Canada holds rate but ends QE as economy improves

     Canada's central bank left its key interest rate steady, as expected, but surprised financial markets by ending quantitative easing (QE) - one of the monetary tools used to provide extraordinary stimulus during the COVID-19 pandemic - due to progress made in the economic recovery.
     The Bank of Canada (BOC) left its target for the overnight rate at the effective lower bound of 0.25 percent, unchanged since it was cut three times in March 2020 at the height of the pandemic.
      In addition to last year's rate cuts, which totaled 1.50 percentage points, BOC also embarked on asset purchases of government bonds and commercial paper - known as quantitative easing (QE) - to keep longer-term interest rates low and financial markets operating smoothly.
      At first BOC bought C$5 billion of government securities a week and later expanded these purchases to include bonds from Canada's provinces and corporate bonds.
      In October last year BOC shifted its purchases toward longer-term bonds and lowered the weekly amount to $4 billion.
      But in April this year BOC became the first developed market central bank to begin rolling back the extraordinary stimulus provided last year and cut the weekly purchases to $3 billion. In July the weekly purchase amount was lowered further to $2 billion as the economy slowly recovered.

      Today BOC took another major step toward normalizing its monetary policy but said it still views the economy as requiring "considerable monetary policy support" in light of the continued excess capacity in the economy.

     "In light of the progress made in the economic recovery, the Governing Council has decided to end quantitative easing and keep its overall holdings of Government of Canada bonds roughly constant," the bank's monetary policy committee said today.

      As bonds mature at different times, BOC will move to a monthly rather than a weekly target for bond purchases and set the purchase range at $4 billion to $5 billion a month. This includes $1 -$2 billion of bonds in the primary market and about $2.5 billion to $3.5 billion in the secondary market.

      BOC described this shift to maintaining its holdings of bonds rather than expanding them as a "reinvestment phase," and said the length of this phase was part of the monetary policy decisions that are based on the strength of the economy and inflation.

     "But as I indicated in September, it is reasonable to expect that we will be there for a period of time, at least until we raise our policy interest rate," BOC Governor Tiff Macklem said about the bond holdings.

      BOC also reiterated its forward guidance, saying it remains committed to keeping its policy rate at the current level until the economic slack is absorbed so the 2 percent inflation target is achieved.

      The central bank expects this to happen in the middle of next year.

      In an update to its monetary policy report, BOC lowered its forecast for economic growth this year to 5.1 percent from 6.0 percent and the 2022 forecast to 4.3 percent from 4.6 percent. Last year Canada's economy shrank 5.3 percent.

     The forecast for inflation this year was raised to 3.4 percent from 3.0 percent and the 2022 forecast to 3.4 percent form 2.4 percent. In 2020 inflation averaged 0.7 percent.

     

     

     The Bank of Canada released the following policy decision followed by a statement by its governor, Tiff Macklem:

"The Bank of Canada today held its target for the overnight rate at the effective lower bound of ¼ percent, with the Bank Rate at ½ percent and the deposit rate at ¼ percent. The Bank’s extraordinary forward guidance on the path for the overnight rate is being maintained. The Bank is ending quantitative easing (QE) and moving into the reinvestment phase, during which it will purchase Government of Canada bonds solely to replace maturing bonds.

The global economic recovery from the COVID-19 pandemic is progressing. Vaccines are proving highly effective against the virus, although their availability and distribution globally remain uneven and COVID variants pose risks to health and economic activity. In the face of strong global demand for goods, pandemic-related disruptions to production and transportation are constraining growth.  Inflation rates have increased in many countries, boosted by these supply bottlenecks and by higher energy prices. While bond yields have risen in recent weeks, financial conditions remain accommodative and continue to support economic activity.

The Bank projects global GDP will grow by 6½ percent in 2021 – a strong pace but less than projected in the July Monetary Policy Report (MPR) – and by 4¼ percent in 2022 and about 3½ percent in 2023.

In Canada, robust economic growth has resumed, following a pause in the second quarter. Strong employment gains in recent months were concentrated in hard-to-distance sectors and among workers most affected by lockdowns. This has significantly reduced the very uneven impact of the pandemic on workers. As the economy reopens, it is taking time for workers to find the right jobs and for employers to hire people with the right skills. This is contributing to labour shortages in certain sectors, even as slack remains in the overall labour market.

The Bank now forecasts Canada’s economy will grow by 5 percent this year before moderating to 4¼ percent in 2022 and 3¾ percent in 2023. Demand is expected to be supported by strong consumption and business investment, and a rebound in exports as the US economy continues to recover. Housing activity has moderated, but is expected to remain elevated. On the supply side, shortages of manufacturing inputs, transportation bottlenecks, and difficulties in matching jobs to workers are limiting the economy’s productive capacity. Although the impact and persistence of these supply factors are hard to quantify, the output gap is likely to be narrower than the Bank had forecast in July.

The recent increase in CPI inflation was anticipated in July, but the main forces pushing up prices – higher energy prices and pandemic-related supply bottlenecks – now appear to be stronger and more persistent than expected. Core measures of inflation have also risen, but by less than the CPI. The Bank now expects CPI inflation to be elevated into next year, and ease back to around the 2 percent target by late 2022. The Bank is closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.  

The Governing Council judges that in view of ongoing excess capacity, the economy continues to require considerable monetary policy support. We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In the Bank’s projection, this happens sometime in the middle quarters of 2022. In light of the progress made in the economic recovery, the Governing Council has decided to end quantitative easing and keep its overall holdings of Government of Canada bonds roughly constant.

We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation target."

      Opening statement by Governor Tiff Macklem:

"Good morning. I’m pleased to be here with you—in person—to discuss today’s policy announcement and the Bank’s Monetary Policy Report (MPR).

It seems fitting that we are back together in this somewhat normal setting as we conclude one part of our extraordinary monetary policy response to this pandemic. This morning we announced that we are ending quantitative easing (QE) after more than year and a half.

We undertook QE first to help restore market functioning and then to boost our monetary policy stimulus. Since last October, in line with progress in Canada’s economic recovery, we have been gradually reducing the pace of our QE purchases. With the economy once again growing robustly, Governing Council judged that QE is no longer needed. This means we will stop growing our holdings of Government of Canada bonds. It is important, however, to remind Canadians that the significant stimulus we have injected through QE remains in place. We just won’t be adding to it. We call this the reinvestment phase. In this phase, we will purchase bonds only to replace those that are maturing so that our overall holdings of Government of Canada bonds remain roughly stable over time.

The end of QE comes as increasing vaccination rates are enabling continued progress in the economic recovery in Canada and around the world. While new complications of reopening continue to crop up and that is boosting the prices of many globally traded goods, I’m struck by how much progress our economy has made since the start of the crisis. We’ve come a long way. And our forecast is for an increasingly healthy economy, even if these complications are going to be with us for a while longer.

We are forecasting annual growth in economic activity will be around 5 percent this year, and about 4¼ percent in 2022 and 3¾ percent in 2023. Global supply chain disruptions and shipping bottlenecks are expected to restrain growth and boost prices into next year. So relative to our forecast in July, growth in Canada is a little lower and inflation takes longer to come back down. The main forces pushing up prices—higher energy prices and supply bottlenecks—now appear stronger and more persistent than we previously thought.

Let me expand on these themes and say a few words about the key points of the Governing Council’s deliberations.

Of course, we discussed the evolution of COVID-19. While vaccination rates are generally very high in Canada and the number of cases in most regions has declined, the pandemic continues to disrupt our lives. Some of the disruptions were expected—we’ve never closed and reopened the economy before, so it was bound to be bumpy. But others, including labour-market frictions and supply disruptions, are more pronounced than anticipated. Let me talk about each of these in turn.

We’ve seen strong job growth in recent months. Many sectors that were hardest hit by lockdowns earlier in the pandemic rebounded strongly as Canadians resumed more normal activities. Strong job growth has reduced the very uneven impacts of the pandemic, particularly for youth and women. However, the recovery of low-wage jobs continues to lag, many people are not working as many hours as they would like, and the large number of people who have been unemployed for more than six months remains a concern.

Slack remains in the labour market. But even as the unemployment rate remains well above pre-pandemic levels, job vacancies have risen sharply. This is unusual.

Our recent Business Outlook Survey indicates that labour shortages have intensified in two areas. The first is shortages of skilled trades and digital workers. This is a challenge that existed before the pandemic as well. The second is more pandemic-specific. As service businesses like restaurants and stores reopened this summer, many had trouble hiring workers quickly enough to meet the surge in demand. Part of this reflects the reality that it simply takes time for companies to find workers with the right skills, and for workers to find the right jobs. Repeated closures in some sectors and the challenges of working in high-contact jobs during a pandemic may also be affecting the workforce. About half of the unemployed workers who responded to the recent Canadian Survey of Consumer Expectations said they’re considering a move to a different industry.

With lots of Canadians still looking for work, and many employers hiring, we expect employment growth to continue in the months ahead. But the process of matching workers and jobs is more difficult than in a typical recovery, and it could take some time to work through these issues.

Governing Council also spent time discussing supply chain disruptions. The global shortage of semiconductors and other manufacturing inputs, as well as shipping and other transportation bottlenecks, are affecting production and delaying deliveries of many goods. While we highlighted some of these problems in our July MPR, they are more widespread and look to be more persistent than we anticipated. Quantifying the impact of these supply factors is difficult, but the implication is that there is likely less excess supply in the economy than we thought there would be. We now expect the output gap to close sometime in the middle quarters of 2022, which is earlier than we projected in July. Let me underline there is more uncertainty than normal around the economy’s productive capacity due to the unusual circumstances of the pandemic.

The combination of on-going supply disruptions and related cost pressures, as well as higher energy prices, is putting upward pressure on many prices around the world. In Canada, inflation is currently running at about 4½ percent. We now expect it will rise to close to 5 percent by the end of this year, before coming back down to around the 2 percent target by the end of next year. In other words, we continue to expect that inflation will ease back, but relative to our July forecast, it is higher for longer.

We know higher prices are challenging for Canadians, making it harder for them to cover their bills. I want to assure you that inflation is not going to stay as high as it is today, even if it is going to take somewhat longer to come down. The Bank of Canada is committed to ensuring that price increases don’t become ongoing inflation. So far, measures of medium- to longer-term inflation expectations remain well anchored on the 2 percent target, and overall wage pressures remain moderate. This suggests that higher prices are not becoming embedded in expectations of ongoing inflation. As these forces play out, it is our job to bring inflation back to target, and I can assure you we will do that.

In view of the continued excess capacity in the economy, my fellow Governing Council members and I judged that the economy still needs considerable monetary policy support. While we ended QE, we kept our policy interest rate at its lowest level, and reaffirmed our commitment to keep it there until slack in the economy is absorbed so that the 2 percent inflation target is sustainably achieved. Based on our current projection, this happens sometime in the middle quarters of 2022.

Let me conclude with some additional information on the end of QE and the shift to reinvestment. Following the announcement of our decision this morning, we issued a market notice outlining in detail the changes to our market operations. Because bond maturities are lumpy, we are moving to a monthly rather than a weekly target range for our purchases. That target range will be $4 billion to $5 billion per month. This includes our purchases in both the primary and secondary markets. As outlined in the market notice, to keep our holdings of Government of Canada bonds roughly stable, we plan to purchase roughly $1 billion to $2 billion per month in the primary market, and roughly $2½ billion to 3½ billion per month in the secondary market.

How long the reinvestment phase lasts is a future monetary policy decision. It will depend on the strength of the recovery and the evolution of inflation. But as I indicated in September, it is reasonable to expect that we will be there for a period of time, at least until we raise our policy interest rate.

We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation target.

With that, let me stop and turn to you for questions."

     www.CentralBankNews.info