Bank of Canada ends quantitative easing and switches to reinvestment phase

• The Bank of Canada kept the overnight rate at the lower effective bound of 0.25%, but made a small adjustment to its extraordinary forward guidance. Quantitative easing ends and as noted in earlier communiques, the Bank is transitioning to the reinvestment phase in which Government of Canada bonds will be purchased to replace maturing bonds on the Bank's balance sheet.
• The Bank lowered its global and domestic growth outlooks for this year and next in the October Monetary Policy Report (MPR). Canada's real GDP growth was cut 0.9 percentage point to 5.1% this year and 0.3 percentage point to 4.3% in 2022. Growth was revised up 0.4 percentage point in 2023 to 3.7%.
• The new inflation outlook is 3.4% for 2021, 3.4% for 2022, and 2.3% for 2023.
• The Bank projects that the 2% inflation target will be sustainably achieved "sometime in the middle quarters of 2022." Given persistent excess capacity amid a backdrop of supply-chain shortage and transportation delays, the Bank's current estimate of the output gap is narrower than forecast in July. As such, IHS Markit experts are revising the Bank of Canada's monetary policy tightening cycle to begin in July 2022.

Built into the Bank of Canada's economic outlook is slower global growth, especially as the COVID-19 Delta variant negatively weighs on consumption in many economies. This results in an uneven global recovery. Yet, the Bank estimates that thanks to Canada's labour market's bounce back as well as a resumption of robust growth, Canada's economic outlook seems to be less choppy and total real GDP will return to fourth-quarter 2019 levels by the end of 2021. Based on the revised real GDP outlook, real GDP levels are anticipated to be lower than forecast in the July MPR as the rebound in domestic demand (consumption and business investment) and exports is softer, but the economic slack will be absorbed sooner than forecast in July.

Canada's elevated consumer price inflation outlook is driven by higher energy prices and more prominent upward supply constraints. In terms of assumptions, the oil-price inputs are about USD5/barrel higher for Brent, West Texas Intermediate, and Western Canadian Select when compared with the July inputs on inflation. Non-energy commodity upward price pressures are more pronounced surrounding metals because of production adjustments despite strong demand. Against this backdrop, the Bank anticipated inflation to moderate to 2% towards the end of 2022, as supply disruptions dissipate, putting less pressure on prices. As supply catches up and the economy shifts to excess demand, 2023 inflation will rise modestly and then return once again to the 2% target in 2024.

The labour market recovery as measured by a few indicators showed improvement for youths and women, yet labour market slack remains as many other indicators are underperforming relative to pre-pandemic levels. This includes average hours worked, the jobless rate, and employment levels for low wage occupations. Therefore, the Bank sees that a fuller recovery is necessary to eliminate labour market slack.

The Bank's extraordinary guidance noted that the Bank remains "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." This timing is slightly earlier than previous announcements. Yet, the projections are surrounded by a high degree of uncertainty. While a rate hike could come as early as April 2022, IHS Markit will pull up the first interest rate hike back to July 2022 from October 2022, which was assumed in the September and October 2021 macroeconomic forecasts.

Posted 19 November 2021 by Arlene Kish, Director, Economics, S&P Global Market Intelligence