–BOC Also Decides To Begin Quantitative Tightening, Gradually Trim Balance
Sheet
–BOC: Russia’s Invasion of Ukraine ‘Causing New Economic Uncertainty’
–BOC Repeats: Timing, Pace of Further Rate Hikes Set by Economic Assessment
–BOC Governor Macklem: Prepared To Be ‘Forceful’ in Rate Hikes If Needed
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday jacked up its policy rate – the
target for overnight lending rates – by 50 basis points to 1% from 0.5%, as widely
expected, after raising it by 25 basis points from its record low 0.25% in March, as
part of its campaign to cool off the red-hot inflation and housing market toward
more sustainable economic growth under price stability.
The bank’s Governing Council also decided to begin the process of quantitative
tightening, effective April 25. It will stop reinvesting in government bonds and let
its swollen balance sheet shrink in line with economic recovery from the
pandemic-caused slump.
“Maturing Government of Canada bonds on the bank’s balance sheet will no
longer be replaced and, as a result, the size of the balance sheet will decline over
time,” the bank said in a statement.
BOC policymakers said the bank has to raise interest rates to a level that is more
neural to economic activity, adding that Canadian households and businesses can
withstand higher borrowing costs.
“We are prepared to move as fast as we need to bring inflation back to target,”
BOC Governor Tiff Macklem told a news conference. “We took an important step
this morning and it’s clear we have more work to do.”
“We signaled that the interest rate needs to rise further. That will moderate
spending growth in Canada, that will bring demand more in line with supply, and
that will bring inflation back to target,” he said. “I do think Canadians are going to
be confident we will control inflation.”
“We are committed to bringing inflation back to target and we are prepared to be
forceful, if needed,” the governor said.
Once the bank gets closer to an interest rate level considered to be neutral to
economic activity, “From there, we probably need to be more humble,” he said.
“If demand responds quickly to higher rates and if there are clear signs of
moderation inflation, it may be appropriate to pause once we are closer to
neutral, at least for a period,” Macklem said.
“But equally we have more work to do. The economy has considerable
momentum. The labour markets are tight,” he said. “If that momentum
continues, we may have to take rates modestly above neutral for a period to
restore balance between supply and demand and bring inflation back to target.”
In its quarterly Monetary Policy Report released Wednesday, the bank estimates
that the nominal neutral rate in Canada currently lies in a range of 2% to 3%, 25
basis points higher than in the April 2021 assessment.
“This upward shift reflects a combination of the revised US neutral rate and key
domestic factors, including stronger growth of trend labour input and trend
output over the long term.”
Senior Deputy Governor Carolyn Rogers also told reporters that bank officials
believe that the overheated Canadian housing market will “moderate over time”
from an extremely elevated level to a still high level. “We don’t think this will have
a big drag on the economy.”
Over the course of the pandemic, household balance sheets have improved as
people have paid down the debt and increased their savings, which will give them
a buffer against rising mortgage rates and interest rates generally, she explained.
“We are hearing from businesses that there is a stronger intention to invest,” she
added. “As the economy recovers, pandemic restrictions come off… we are
expecting some business investment pickup.”
The central bank started its credit tightening cycle last month by conducting its
first interest rate hike since October 2018 by gradually removing extra monetary
easing that is not needed any longer, given improving employment conditions and
resilient consumer spending.
Asked whether the bank should normalize its balance sheet immediately,
Macklem said the bonds on the bank’s balance sheet are “relatively short term,”
and so it will see a marked runoff, about 40%, of its balance sheet over the next
two years.
“With a fairly good runoff, at this time we don’t see the need to actively sell
bonds,” he said.
BOC Revises Up Inflation Forecast
In its Monetary Policy Report, the bank revised its consumer inflation outlook for
2022 sharply to 5.3% from 4.2% projected in its previous report issued in January,
accelerating from 3.4% in 2021, while raising its CPI forecast for 2023 to 2.8%
from 2.3%.
In its first estimate for Canada’s CPI in 2024, the bank forecast an annual rate of
2.2%, close to its 2% target.
CPI inflation in Canada, which stands at 5.7%, is now expected to average almost
6% in the first half of 2022 and remain well above the control range throughout
this year before easing to about 2.5% in the second half of 2023 and return to the
2% target in 2024, the bank said.
“There is an increasing risk that expectations of elevated inflation could become
entrenched,” the BOC warned in its policy statement. “The bank will use its
monetary policy tools to return inflation to target and keep inflation expectations
well-anchored.”
Asked about the possibility that crude oil prices continue rising, instead of easing,
Macklem had no direct answer but said, “We are more concerned about upside
risks to inflation than downside risks.”
The bank revised up its 2022 economic growth forecast slightly to 4.2% from its
January projection of 4.0%, following a robust 4.6% gain in 2021, but revised
down its 2023 GDP growth forecast to 3.2% from 3.5% amid uncertainty. It
expects the domestic economy to slow to 2.2% in 2024.
“The Canadian economy has strong momentum, and employment is robust,” the
bank said in the report. “While COVID‑19 continues to affect people’s health and
the economy, high vaccination rates are lessening severe impacts. Household
consumption spending is strengthening as most public health containment
measures are being lifted, and exports are expected to benefit from solid foreign
demand.”
The bank expects Canada’s economic activity to “remain strong.” Consumer
spending, exports and business investment are projected to “grow solidly,”
backed by healthy foreign demand, high commodity prices and the easing of
supply disruptions, it said.
“Higher interest rates should moderate spending and gradually reduce
excess demand in the Canadian economy,” it added.
Macklem noted that the bank’s latest economic projections did not incorporate
net new fiscal measures, which are estimated at about C$30 billion over five years
and thus a “positive impulse,” but added that those measures are unlikely to have
a major impact on the bank’s GDP and CPI forecasts.
He also said the projections are based on the current exchange rates.
Asked about the strength of the Canadian dollar, Macklem said the bank does not
have exchange rate target or forecast but gave a couple of factors that may
explain why the currency is not appreciating exactly in tandem with rises in
commodities prices.
Amid a surge in energy prices, Canada is not getting much of an investment from
the oil patch, which may be also looking longer-term to a transition toward zero
carbon growth, Macklem said.
The Canada-US interest rate differential has widened on expectations for more
aggressive tightening by the Federal Reserve, with the US yield curve steepening
fast at one point. “That may also be weighing on the Canadian dollar.”
Ukraine Invasion Causing ‘New Economic Uncertainty’
Russia’s ongoing invasion of Ukraine is “causing new economic uncertainty,” the
bank said. Last month, it described it as “a major new source of uncertainty.”
“Price spikes in oil, natural gas and other commodities are adding to inflation
around the world. Supply disruptions resulting from the war are also exacerbating
ongoing supply constraints and weighing on activity,” the BOC said.
These factors are the primary drivers of a substantial upward revision to the
bank’s outlook for inflation in Canada, it said.
Timing, Pace of Further Rate Hikes Up to Data
“With the economy moving into excess demand and inflation persisting well
above target, the Governing Council judges that interest rates will need to rise
further,” the bank said.
“The policy interest rate is the bank’s primary monetary policy instrument, and
quantitative tightening will complement increases in the policy rate,” it said, and
largely repeated its March statement: “The timing and pace of further increases in
the policy rate will be guided by the bank’s ongoing assessment of the economy
and its commitment to achieving the 2% inflation target.”
To defend the economy from the first wave of the pandemic, the BOC conducted
three rate cuts totaling 150 basis points in March 2020, lowering the policy rate to
0.25% from 1.75%, a level maintained for more than a year since it was raised
from 1.50% on Oct. 24, 2018.
As an emergency measure, the bank began buying government debt in March
2020 to provide liquidity and ease market strains, but in July that year, it formally
called the program “quantitative easing (QE),” using the tool to support the economy by keeping market interest rates low.
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Contact this reporter: max@macenews.com
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