Bank of Canada Interest Rate Announcement (July 14, 2021)

The Bank of Canada reduces bond purchases, expects economic slack to be absorbed in the second half of 2022 

• The Bank of Canada (BoC) kept the overnight rate at 0.25% but continued to taper the quantitative easing (QE) program. The Bank reduced the pace of asset purchases from at least $3 billion per week to $2 billion per week.
• In terms of the overnight rate, the Bank said that the interest rate would remain at its effective lower bound until economic slack is absorbed and the 2 percent inflation target is sustainably achieved, which it continued to expect would occur in the second half of 2022.  
• The Bank of Canada also released the July Monetary Policy Report (MPR) today. The economic forecast has incorporated sizeable changes from the April edition. For 2021, real GDP growth was revised down half a percentage point to 6%, 2022 was upgraded to 4.6% from 3.7%, and 2023 was little changed at 3.3%. The downgrade in 2021 comes as a result of a weaker than expected first half of the year, but the Bank continues to expect a strong rebound in growth in the third and fourth quarters. The upward revision in 2022 was mainly a result of the BoC now assuming that households will spend 20 percent of the extra savings they accumulated during the pandemic on consumption. Previously, they had expected none of these funds would be used for consumption purposes. 
• The Bank also lifted potential GDP growth in 2021-23 to average around 1.8% per year, approximately 0.2 percentage points higher than what was assumed in the April MPR. As a result, combined with the real GDP forecast, the Bank continues to expect the output gap to close sometime in the second half of 2022.
• In terms of inflation, the consumer price index (CPI) inflation forecast was revised higher. The 2021 forecast was increased to 3% from 2.3%, and 2022 was revised up to 2.4% from 1.9%. The projection for 2023 was pretty much unchanged at 2.2%. 

Key Implications

• As was widely expected, the Bank of Canada opted to reduce monetary stimulus today. With the economic recovery strengthening on the back of easing public health restrictions, it was a prudent move by the Bank to remove some policy support.
• Still, considerable monetary stimulus is flowing into the economy and with the labour market still quite a long way away from a full recovery, the BoC will not be turning off the taps anytime soon. Today's MPR reiterated that it will take time for a full and inclusive recovery in employment, especially as workers take on new jobs. 
• However, labour market slack has not blunted near-term price pressures. In fact, the Bank now expects inflation to push higher than its previous forecast aided by reopening and supply chain impacts. But just as in April, the BoC believes transitory forces are lifting inflation currently and they will fade with time. Even so, the Bank's commitment to keep the policy rate at its effective lower bound well into 2022 will lead to inflation moving above the 2 percent target in 2023 before returning a year later. The Bank recognizes there is a lot of uncertainty around inflation at the moment, so it will continue to closely watch the persistence and magnitude of price pressures as the economy reopens.    

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