The Bank of Canada is cutting the pace of its government bond purchases, bringing forward the timing of interest rate hikes after sharply raising its growth expectations for the Canadian economy.
The Bank of Canada said Wednesday that it will reduce its bond purchases from the Canadian government to C$3 billion a week from C$4 billion in quantitative easing. At the same time, the central bank will also maintain the current interest rate at 0.25%, but will accelerate the time to raise interest rates, which is expected to be moved from 2023 to the second half of 2022.
The Canadian economy is forecast to grow by 6.5 per cent this year, up from January’s forecast of 4 per cent and significantly higher than the 5.8 per cent growth rate forecast used by the federal government in its budget on Monday.
The revision is due in large part to stronger-than-expected growth in the first quarter. In the first three months of the year, GDP growth is forecast to reach about 7 percent, 9.5 percentage points higher than the bank’s forecast in January at the time, despite the second wave of the epidemic hitting Canada.
In its rate decision on Wednesday, the central bank said, “The economic recovery is now more resilient than expected in the face of the pandemic, and in addition vaccine administration is moving forward.” It added: “The recovery depends to a large extent on the current evolution of the epidemic and the pace of vaccination.”
Prior to that, quantitative easing was also widely expected to be reduced by $1 billion. The central bank has been buying government bonds in an attempt to hold down benchmark interest rates and thus bring down the cost of borrowing in the market.
In the past year, the central bank has been buying billions of dollars worth of government bonds each week and now owns 42 percent of the federal government’s bond supply. Economists say the bank needs to “reduce” the pace of its purchases to avoid causing problems in the bond market.
The bank said it will adjust the amount of stimulus it adds to the bond market each week accordingly, depending on the progress of the economic recovery.
A more important change is the central bank’s forward guidance on interest rate hikes. Since last summer, the Bank’s interest rate has been held at an “effective floor” of 0.25% until the economy recovers and inflation can stabilize at 2%. Both of these conditions are now expected to be met by the second half of 2022, rather than by 2023.
Regarding the inflation rate, the central bank expects the consumer price index to grow close to 3 percent in the coming months, mainly due to the pull of gasoline prices. The central bank also expects inflation to be 2.3 percent in 2021, 1.9 percent in 2022 and 2.3 percent in 2023.
In the central bank’s quarterly monetary policy report released Wednesday, while Canada’s economy is recovering, the third wave of the epidemic “has brought new setbacks. But they expect the impact on the economy to be “temporary”.
If not for the adaptive changes Canada has made in the second wave of the epidemic and the increasing number of people starting vaccinations. The impact of the third wave of the epidemic will now be more severe and long-lasting. The central bank predicts that the current public health restrictions will be lifted by the end of May.
Also the rebound in the labor market is supporting the improvement in the economic situation. In March, Canada added about 300,000 jobs, bringing the unemployment rate down to 7.5 percent. However, the central bank warned that the recovery in the labor market is not comprehensive and sectors such as accommodation and food services are still struggling at the moment.
The report also pointed out that this third wave of blockade will bring another round of impact on the labor market, especially many low-wage workers, young people and women will face difficulties.
Following a downward revision last October, the central bank has revised its expectations for potential output growth. The Canadian economy is expected to grow potential output by an average of about 1.6 per cent over the next three years. This reflects a smaller-than-expected shock to Canada’s labour force, as well as greater-than-expected business investment in areas such as automation and digitalization.
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