As widely expected, the Bank of Canada (BoC) announced this week that its target for the overnight rate will remain at 0.25%. Relatedly, the pace of asset purchases – part of the BoC’s quantitative easing program – will also stay put at $2 billion per week. Remember, this was reduced from $3 billion at the Bank’s July rate announcement.
Global economy continues to recover but remains hampered by supply chain issues and COVID-19
Despite the ongoing recovery in the second quarter (led by strong growth in the U.S.) and considerable momentum heading into the third quarter, economic activity in many sectors remains below capacity due to pandemic-related supply chain disruptions. Rising COVID-19 cases in some regions and new virus strains also continue to drag on the strength of the global recovery.
Canadian GDP shrank by ~1%
In Canada, growth was weaker than what was anticipated in the July Monetary Policy Report (MPR). The Bank explained that a reduction in exports (it cited the automotive sector as an example) due in part to supply chain disruptions as the primary cause.
On the positive side, consumption, business investment and government spending all continued to be positive contributors to Canadian growth. Housing activity cooled from recent highs; however, employment rebounded throughout the summer.
As stated in its announcement, “The Bank continues to expect the economy to strengthen in the second half of 2021, although the fourth wave of COVID-19 infections and ongoing supply bottlenecks could weigh on the recovery.”
Inflation still not a major concern
As expected, inflation remains elevated (CPI inflation remains over 3%), boosted by the base effect (my colleague Mark Fairbairn does a great job explaining what this is in this article) and demand and supply imbalances brought about by the pandemic. The BoC expects this to be temporary, as do we.
The Bank’s expectations are in line with our expectations
Financial conditions remain highly accommodative and the BoC restated that “the recovery continues to require extraordinary monetary policy support.” The Bank is also being abundantly clear with its forward guidance, again confirming it will hold the target for the overnight rate at 0.25% until excess capacity is absorbed and 2% inflation is sustainably achieved (the Bank expects this in the second half of 2022 according to the July MPR).
Correspondingly, our portfolios remain overweight equities relative to fixed income at this time. While the BoC’s current monetary policy support is designed to keep rates low across the yield curve, we believe that longer-term rates will modestly increase as the economic recovery gradually takes hold. As rates will eventually start to creep up, we continue to focus on short duration (less interest rate sensitive) exposure with respect to our fixed income positioning. The intention is to preserve capital as rates migrate modestly higher and, from a carry perspective, reflects our belief that current rates are too low for having the relatively higher risk of holding a long duration position.
For more information, please contact your MD Advisor*.
Note that the Bank’s next interest rate announcement is scheduled for October 27th which will coincide with the latest MPR.
* 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.