As most expected, the Bank of Canada (BoC) decided to maintain its target overnight rate at 0.25% on Wednesday morning. At this time, the market is not pricing-in a rate increase for the next 2 years. Additionally, the BoC reported that its programs initiated to facilitate core market functions during the recent downturn were improving short-term market conditions.
A more positive tone from the BoC supported a modest increase in mid- and long-term Canadian treasury yields and an appreciation of the Canadian dollar relative to the U.S. dollar. Led by financial stocks, Canadian equities also moved positively – having more to do with global movements than the interest rate announcement.
COVID-19 hurt the global economy, but it appears the worst-case scenario was avoided
It’s clear that the pandemic has had a severe negative impact on the global economy and financial markets as economies essentially shutdown. The unprecedented coordinated policy efforts of governments around the world has provided a much-needed cushion. I would agree with the BoC in that the negative impact appears to have peaked. However, as restrictions ease unevenly across regions, uncertainty remains, and the global economic recovery is likely to be prolonged.
The BoC reports that financial conditions have improved, and commodity prices have come back up. “In Canada, the pandemic has led to historic losses in output and jobs. Still, the Canadian economy appears to have avoided the most severe scenario presented in the Bank’s April Monetary Policy Report (MPR). The level of real GDP in the first quarter was 2.1% lower than in the fourth quarter of 2019.”
The second quarter is likely to be weak, but things are looking up for the third
Given the timing of the pandemic and the recent oil price shock, it’s expected that real Canadian GDP will decline further in the second quarter of 2020. The BoC estimates an additional 10-to-20% decline as the shutdowns continue to impact output. This suggests a peak-to-trough decline that is also less severe than previously expected. While the outlook going forward remains highly uncertain, the BoC expects the economy to resume growth in the third quarter.
Scaling back support
As conditions have improved, the BoC also reported that it would reduce the frequency of some of its market support measures – though it was quick to point out that it remains ready to adjust its programs based on prevailing market conditions. It’s also important to note that other programs, such as the purchasing of federal, provincial and corporate bonds will continue until the economic recovery is well underway.
Combined with the target overnight rate remaining at its lower bound, these extraordinary policy measures continue to be highly stimulative and required to support an economy that is far from operating at full capacity with inflation well below the BoC’s target (2.0%).
The BoC closed it statement with a reminder that its focus will begin to shift back towards the resumption of economic growth, maximum employment and its inflation target.
No shake up to strategy
Despite the BoC’s more positive tone, we don’t expect a tightening in policy in the foreseeable future even as new Governor Tiff Macklem’s era begins. As such, no major adjustments to our portfolio positioning is required following the BoC’s announcement.
For more information, please do not hesitate to contact your MD Advisor*.
* 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.