Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud

Bottom line

As we expected, the central bank left its policy rate unchanged at 0.25% and entered the “reinvestment phase” of its quantitative easing program. However, the main change to the Bank’s statement is that it now expects to raise its policy rate in the “middle quarters of 2022,” sooner than previously stated.

The press release makes it clear that the BoC is gradually becoming concerned by the persistence of inflation. As such, the main change to the BoC’s forecast is that inflation is expected to remain elevated for some time and unlikely to return to the 2% target before the end of 2022. The statement also makes it clear that the central bank stands ready to keep inflation under control and will be closely monitoring inflation expectations to ensure inflationary pressures do not become entrenched.

While the BoC came out slightly more hawkish, their change to the forward guidance is in line with our expectations. As such, we continue to expect the BoC will start to increase its policy rate in July 2022. However, we do not know if the risks are tilted towards an earlier rate hike if the recovery progresses faster or inflation expectations were to rise.

The BoC left its policy rate unchanged at 0.25% and end its large-scale asset purchases (LSAP) program or quantitative easing (QE). This was in line with market expectations. However, the end of the QE program doesn’t mean the Bank of Canada will no longer buy government bonds. The central bank is entering the “reinvestment phase,” where it will purchase government bonds solely to replace maturing bonds, keeping its holding of government bonds constant.

The Governing Council also reiterated that it “remains committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the two percent inflation target is sustainably achieved.”

The BoC moved forward the moment it expects the economic slack will be absorbed to the middle quarters of 2022 in its latest projection from the second half of 2022 previously. This suggests that the central bank believes it could start increasing its policy rate by mid-2022.

The central bank expects global growth to be strong but slightly slower than in July. The global recovery is supported by continued progress on vaccination – especially in advanced economies – but remains dependant on the evolution of the virus. Nevertheless, “in the face of strong global demand for goods, pandemic-related disruptions to production and transportation are constraining growth.” The BoC also notes that high energy prices and supply bottlenecks are likely to lead to higher inflation globally.

Robust economic growth in Canada has resumed. The BoC acknowledges that the recent employment gains have been concentrated in the sectors affected by the COVID-related restrictions. As a result, it “reduced the very uneven impact of the pandemic on workers.” However, it also notes that labour shortages remain important and will take time to disappear.

As a result of the setback to the recovery in the second quarter, the BoC’s growth forecast was revised lower for 2021 to 5.1% from 6.0%. Similarly, growth for 2022 is also expected to be milder at 4.3% (4.6% previously), while growth for 2023 has upgraded to 3.5% from 3.1%.

The BoC views that the rise in inflation “appears to be stronger and more persistent than expected.” This can be seen in the main changes to the inflation forecast. Inflation for 2021 was revised higher to 3.4% from 3.0%, and for 2022 up to 3.4% from 2.4%. The sharp increase in expectations means that inflation returns to the BoC’s target much later than in the July projection. The Bank will be vigilant on the inflation by saying it will be “closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.”

Independent Opinion

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