- Bank of Canada’s overnight rate remains 0.25%.
- Quantitative easing is ending.
- Pandemic-related factors pushing short-term inflation higher are more persistent than expected.
There was no change in the Bank of Canada's (BoC) overnight rate at October’s interest rate announcement – the target remains at 0.25%. Overall, the Bank says it is committed to holding the policy interest rate steady until slack in the economy is absorbed.
Perhaps more interestingly, the Bank is ending its quantitative easing (QE) program and moving into what it calls the reinvestment phase, during which it will purchase government bonds only to replace those that are maturing.
While the BoC’s stance on COVID-19 remains the same (variant strains still pose a risk to the recovery that’s being driven by restrictions easing and the continuation of vaccine rollouts), the Bank's language about inflation is notable. “The main forces pushing up prices now appear to be stronger and more persistent than previously thought.” That said, the Bank still believes the spike in inflation is temporary.
“Pandemic-related disruptions to production and transportation are constraining growth. Inflation rates have increased in many countries, boosted by these supply bottlenecks and higher energy prices,” they add.
Growth expectations lower now, higher later
As a result of these supply-side constraints, growth has been pushed out. The Bank projects that the global economy will grow by 6.5% in 2021, by 4.25% in 2022 and about 3.5% in 2023 in the October Monetary Policy Report (MPR). This compares to 7%, 4.5% and 3% previously projected in the July MPR.
In Canada, the Bank now forecasts that the economy will grow by 5% this year before moderating to 4.25% in 2022 (this is down from 6% and 4.5%). In 2023, growth is expected to come in at 3.75%, up from the 3% previously anticipated.
Inflation will remain elevated in the short term
The Bank says it now expects inflation to remain elevated into next year before easing back to the 2% target in the later part of 2022. Among the reasons for higher inflation, the Bank says about one-third of inflation in the fourth quarter is projected to come from higher energy prices, ongoing supply disruptions and the rebound in demand for in-person services.
Inflation has become a slightly bigger concern for the BoC, stating “The Bank is closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.”
Markets react accordingly
We saw short-term yields on the Canadian government bond yield curve increase materially and the Canadian dollar appreciate against the U.S. dollar following the quantitative easing news and the increased likelihood of multiple interest rate hikes over the next two years. Equity markets dropped following the announcement, but the root cause is likely global given foreign markets also took a hit.
Supportive conditions remain
The Banks says the output gap is believed to have narrowed in recent months. With economic slack being absorbed sometime in the middle of 2022, it is more likely that rate hikes will now be required earlier than previously expected. However, financial conditions remain supportive of equity markets.
Within our portfolios, we remain underweight fixed income relative to equities. Within our fixed income exposure, we continue to hold a shorter than benchmark duration position. With tapering expected along with rate hikes in the near future, we expect the yield curve to flatten and have positioned accordingly.
Although we are still overweight equities overall, particularly to U.S. and international markets, it is worth noting that this overweight has trended downwards in recent quarters. For more information about this, or about any of your holdings, please contact your MD Advisor*.
The BoC’s next interest rate announcement is scheduled for December 8, 2021.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.