Bank of Canada Interest Rate Announcement (April 21, 2021)

The Bank of Canada tapers QE program, sees economic slack being absorbed in the second half of 2022 

• The Bank of Canada (BoC) held its key policy interest rate at 0.25% but recalibrated its quantitative easing (QE) program by reducing the pace of asset purchases from at least $4 billion per week to $3 billion per week.
• On when it will raise the overnight rate, the Bank reiterated that it will keep the interest rate at the effective lower bound until economic slack is absorbed and the 2 percent inflation target is sustainably achieved. However, the Bank now sees this occurring in the second half of 2022, earlier than its previous communication that this would happen in 2023.
• Along with its monetary policy announcement, the Bank released the April Monetary Policy Report (MPR) today. The 2021 economic forecast was revised up considerably to 6.5% from 4.0% as presented in the January MPR. Real GDP growth in 2022 was revised down to 3.75% (January: 4.8%), and 2023 moved higher to 3.25% (January: 2.5%). In level terms, real GDP is about 2.5% higher in 2021, 1.5% above in 2022, and 2.0% higher in 2023.  
• In addition, the BoC saw less scarring in the economy than previously thought due to the greater-than-expected resilience of activity. As a result, potential GDP was revised up by 0.5 percentage points on average from 2021 to 2023 to 1.6%.
• On inflation, the Bank sees inflation temporarily rising to the top of the 1 to 3 percent inflation target range due to base-year effects and rising oil prices. The Bank will look through these transitory movements in inflation. In the forecast, inflation is expected to rise to 2.3% in 2021, before weakening to 1.9% in 2022, then rising again to 2.3% in 2023.

Key Implications

• No big surprises from the Bank of Canada decision today. As expected, the Bank began tapering the QE program, but opted to keep the overnight rate at 0.25%. There's no question the economy has been outperforming the Bank's expectation recently, necessitating the removal of some monetary stimulus, but at the same time, the third wave is injecting uncertainty in the forecast. 
• That said, given the resilience shown by the economy so far through the pandemic, the Bank decided to change up the forward guidance by pulling forward when it expected economic slack to be absorbed from sometime in 2023 to the second half of 2022. This was an act of transparency by the Bank, founded in the upgrade to its economic forecast in spite of the current third wave of the pandemic.
• The Bank of Canada will be watching vaccine and virus developments closely. The speed of the economic recovery is dependent on vaccines winning the race against COVID-19 and its variants. This is the key downside risk in the Bank's projection and bad news on this front could see the Bank delay its plans for when monetary policy will normalize.  

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