Bank of Canada Leaves Overnight Rate to 0.25%

The Bank of Canada Does Not Expect to Raise Its Policy Rate Until 2023

• The Bank of Canada kept its key policy interest rate at 0.25% and opted to leave the quantitative easing (QE) program operating at its current pace of at least $4 billion per week.
• The Bank continued to provide extraordinary forward guidance as it stated it will hold the policy interest rate at the effective lower bound until economic slack is absorbed and the 2 percent inflation target is sustainably achieved. Just as in the past decision, the Bank does not expect this to happen until into 2023. In terms of the QE program, the Bank said it will keep it running until the recovery is well underway, but it will adjust the pace of net purchases given the strength of the recovery. 
• In addition to the decision, the Bank released the January Monetary Policy Report (MPR) which included revisions to the forecast presented in October. Given the resurgence of the virus and renewed restrictions, the Bank expects growth in the first quarter to contract by 2.5% (annualized). However, as restrictions are lifted through the first quarter, the Bank sees growth picking up quickly in the second quarter. Citing the earlier-than-expected availability of vaccines, fiscal policy measures, stronger foreign demand, and higher commodity prices, the Bank moved up its medium term forecast. Although 2021 growth was brought slightly lower to 4% (October: 4.2%), likely due to the first quarter contraction, the 2022 projection was increased by 1.1 percentage points to 4.8% (October: 3.7%). The Bank introduced the 2023 forecast, which stood at 2.5%.
• An important factor behind the Bank of Canada's strong growth projections in 2022 and 2023 are fiscal stimulus assumptions. The Bank noted that federal and provincial support measures introduced since early 2020 amounted to around 25% of pre-pandemic GDP (2019 Q4), and that additional stimulus of $70-$100 billion was announced in the Fall Economic Statement from November. While acknowledging that there are little details on this stimulus, the Bank has incorporated some of the impact in its projection.
• The Bank also revised up potential GDP, which in turn allowed for its continued expectation of economic slack only being absorbed sometime in 2023. With positive vaccine developments, the Bank sees more business investment and less scarring on businesses and workers. As such, annual inflation rises to just above 2% in 2023. 

Key Implications

• The Bank of Canada decided to keep the overnight rate unchanged today, despite some murmurs on an impending micro-rate cut. Recent speeches seems to have driven this speculation, and the Bank appeared to be non-committal on what the effective lower bound is by stating that it "will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved."
• Looking through this chatter, the Bank came through with a strong upgrade to its projection. One that it felt was "more secure" compared to the October forecast given positive vaccine developments and additional fiscal stimulus measures, mainly. However, there continues to be elevated uncertainty, and the outlook is highly dependent on the path of the vaccine and virus rollout. For the time being, the Bank judged that current monetary support was appropriate.
• A key factor the Bank did not include in its forecast is the use of excess savings. Households have accumulated around $150 billion (6.4% of GDP) in additional savings over the second and third quarters of 2020 relative to the pre-pandemic period. If this money is deployed as the economy opens up, growth could be stronger than the Bank anticipates. If this generates sizeable inflationary pressures, it may push the Bank to move earlier than expected. Time will tell.   

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