E-sight December 9: Bank of Canada Holds the Line

To no one’s surprise, the Bank of Canada left interest rates unchanged and monetary policy unaltered at its announcement today. The benchmark overnight rate will remain at the effective lower bound of 0.25% and the Bank will continue with its asset purchase program worth $4 billion per week.

Explicit forward guidance is one of the tools that the Bank of Canada is currently using to support its ultra-accommodative policy stance. Forward guidance involves telling markets how long they expect to keep current policy in place. And, the central bank has been clearly communicating that large-scale stimulus will be needed for an extended period of time. This clear message helps to keep future interest rate expectations low, thereby contributing to lower bond yields. Thus, there was no doubt that policy would be left unchanged, which also explains why there was no financial market reaction to the announcement.

So, the most interesting part of the communique is the Bank’s assessment of the recent pandemic developments on the near-term economic outlook. In its October Monetary Policy Report, the Bank had forecast that economic growth would stall to just 0.2% in the final quarter of the year and today acknowledged that there was more momentum heading into the fourth quarter than expected, which means that they are likely to revise up that estimate when their next outlook is produced.

While economic conditions look better than expected in the rear-view mirror, the Bank did flag renewed lockdowns and other restrictions, both domestically and abroad, as weighing on growth in the first quarter of next year.

The bank’s projections are aligned with our own economic outlook which indicates a sharp slowdown in growth in the fourth quarter and continued economic struggles into the first quarter. As the vaccine reaches more Canadians and warmer weather allows for more outdoor activities, we should see growth begin to accelerate in the second quarter of next year.

As noted, the Bank’s forward guidance is embedded in market expectations and that holds true for Deloitte’s economic forecast as well. Given what we’ve heard from the Bank and given our own estimates for the lengthy time it will take to absorb the significant economic slack that has built up, we do not foresee the Bank beginning to raise rates until 2023. Stay tuned for more details on our latest forecast which will be available on December 17th.

Categories: Bank of Canada, E-Sight, Economics, Uncategorized

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