Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud
As we expected, the central bank left its policy rate unchanged at 0.25% and continued the “reinvestment phase” of its QE (quantitative easing) program. The main change was the removal of the forward guidance, with the Bank of Canada (BoC) signalling that the economic slack has been absorbed and that interest rates will need to increase. Moreover, the BoC also suggested that it could start to reduce the size of its balance sheet once it hikes interest rates.
The release of the Monetary Policy Report shows that the BoC continues to expect growth to remain robust in Canada, albeit slightly slower than in October. Moreover, it expects inflation to stay close to 5% in the first half of 2022 but to quickly moderate to around 3% in the second half of the year.
Overall, today’s BoC decision was in line with our expectations and does not change our view of monetary policy for the coming year. We continue to expect the BoC to start its policy tightening at the March 2 meeting. We believe the central bank will hike again at the April, June and October meetings, bringing the policy rate to 1.25% by year-end.
The BoC left its policy rate unchanged at 0.25% but removed its forward-guidance, signalling that rate hikes are imminent. This was in line with our expectations, but the market was divided regarding whether the central bank would hike or not. The statement makes it clear that it will increase its policy rate very soon, saying that the economic slack is now absorbed and “the Governing Council expects interest rates will need to increase, with the timing and pace of those increases guided by the Bank’s commitment to achieving the 2% inflation target.”
The BoC also maintained the reinvestment phase of its QE program “at least until it begins to raise the policy interest rate.” However, “the Governing Council will consider exiting the reinvestment phase and reducing the size of its balance sheet by allowing roll-off of maturing Government of Canada bonds,” suggesting that we could start to see a gradual reduction in the size of the BoC’s balance sheet in the coming months.
The central bank expects the global recovery to remain robust despite some cooling in some regions. The Bank also notes that “strong global demand for goods combined with supply bottlenecks that hinder production and transportation are pushing up inflation in most regions.” The BoC notes that “financial conditions remain broadly accommodative but have tightened with growing expectations that monetary policy will normalize sooner than was anticipated.” The Bank projects global GDP to grow by 6.5% in 2021 and 3.5% in 2022 and 2023.
The BoC notes that the Canadian economy “entered 2022 with considerable momentum” and “a broad set of measures are now indicating that economic slack is absorbed.” The BoC acknowledges that the Omicron wave of the pandemic will weigh on economic activity in the first quarter, but “it is expected to be less severe than previous waves.” The Bank now expects growth to reach 4.6% in 2021, lower than the 5.1% in the October Monetary Policy Report. However, growth was revised lower to 4.0% in 2022 (4.3% in October) and 3.5% (3.7% in October) as a result of the Omicron variant, weaker global growth and persistent supply constraints.
The BoC continues to view the elevated inflation due to persistent global supply constraints. The Bank expects inflation to be close to 5% in the first half of 2022 and notes that the “supply constraints are feeding through to a broader range of goods prices and, combined with higher food and energy prices.” The central bank continued to expect inflation to moderate in the second half of the year, declining rapidly to 3%, higher than expected in the October MPR. The BoC notes that some of the high inflation has to push near-term inflation expectations but that long-term expectations remain well-anchored.
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