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The Bank of Canada marches on with supportive policy

The exterior building of the Bank of Canada.

There were no surprises in Tiff Macklem’s first interest rate announcement as Governor of the Bank of Canada (BoC). As widely expected, the BoC decided to hold its overnight lending rate at 0.25%. Furthermore, the BoC will continue its large-scale asset purchase program (quantitative easing) to the tune of at least $5 billion per week of Government of Canada bonds. Provincial and corporate bond purchase programs will also continue as announced.

I believe the key takeaway from the announcement is that the BoC is guiding a continued commitment to supportive policy conditions which can be argued as a change from the previous Governor’s focus on data dependency.

Global outlook remains uncertain despite economies re-opening

After the pandemic-driven drop off in the first half of 2020, global economic activity is starting to pick up. The combination of economies re-opening and the unprecedented global fiscal and monetary policy has dramatically improved financial conditions.

While pandemic-related restrictions ease, it is important to observe that the global economic outlook remains fairly uncertain given the unpredictable nature of the pandemic. Recovery timelines and pace are different across geographic regions and the outlook could be vulnerable by an increase in infections.

Accompanying the interest rate announcement was the latest Monetary Policy Report (MPR). Under the assumption that a second widespread wave does not occur (the BoC’s main scenario), the BoC expects the global economy to contract by about 5% in 2020, followed by about 5% on average growth in 2021 and 2022, with the virus running its course by mid-2022.

The BoC also made special note of the potential for spending behaviour to change the course of the economic recovery as consumer priorities and work patterns evolve. Despite the BoC articulating a large recovery in the coming years in its main scenario, global output will not return to levels projected in the January 2020 MPR by the end of 2022 which speaks to the uncertainty surrounding the scenario.

In Canada, policy action continues to act as a cushion and the foundation for recovery

Domestic activity has already picked up with the number of new COVID-19 cases in Canada having fallen since April and remaining relatively low. In turn, a phased re-opening of businesses supports a sharp near-term recovery followed by a more gradual return to pre-pandemic levels.

Again, decisive and critical fiscal and monetary policy actions have supported the Canadian economy throughout the pandemic and has provided a nice springboard for recovery. More importantly, confidence has been provided to market participants that support will remain in place as the Canadian economy continues to work through the pandemic.

In its main scenario, the BoC expects approximately 40% of the collapse experienced in the first half of 2020 to be made up for in the third quarter. However, “the Bank expects the economy’s recuperation to slow as the pandemic continues to affect confidence and consumer behaviour and as the economy works through structural challenges.”

As a result, the BoC expects real GDP to shrink by 7.8% this year, grow by 5.1% in 2021 and by 3.7% in 2022.

Supportive policy will continue until sustainable improvements are achieved

Although the domestic economy has avoided the worst-case scenario from April’s MPR and is positioned for a near-term partial recovery, the BoC remains committed to accommodative policies until sustainable improvements can be seen in the labour market, consumer and business confidence, supply chains, and demand.

In its statement, the BoC noted that “as the economy moves from re-opening to recuperation, it will continue to require extraordinary monetary policy support. The Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2% inflation target is sustainably achieved.”

The BoC’s core inflation measures are now sitting below the 2% target and are expected to remain low as temporary supply issues (like lower gas prices) dissipate and demand increases.

In addition to keeping rates at the lower bound, the BoC’s quantitative easing program will continue to provide support to households and business. The BoC remains committed to supporting the Canadian economy until the recovery is well underway. The BoC also “stands ready to adjust its programs if market conditions warrant.”

The BoC announcement is aligned with our expectations for supportive monetary policy, subdued inflation, and cheaper borrowing rates for consumers and businesses for the foreseeable future. As a result, no modifications are required at this time to our portfolio positioning. There was little change to the CAD/USD rate immediately following the announcement and the Canadian government’s short-term lending rates modestly declined.

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.

About the Author

Wesley Blight, CFA, CIM, FCSI, is a Portfolio Manager with the Multi-Asset Management Team of 1832 Asset Management L.P. He is responsible for the investment results of the firm’s fixed income and multi-asset products.

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