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January 20, 2021BANK OF CANADA MONETARY POLICY The Bank of Canada will hold rates at the effective lower bound with the overnight rate at 0.25%, the Bank Rate at 0.50% and the deposit rate at 0.25%. The Bank noted that it is maintaining its forward guidance and quantitative easing program at its current pace of a minimum $4 billion per week. Given the current weakness and projected recovery, it is expected the economy will require extraordinary monetary policy support. The Bank of Canada noted that they will hold policy interest rates until economic slack is absorbed and inflation is at the 2% target in a sustainable manner. This is not projected to happen until 2023.
Many countries, including Canada, have experienced setbacks with rising COVID-19 numbers and renewed public health measures and lockdowns. Earlier vaccination timelines have moved up prospects for broad immunity and medium-term economic growth. However, until the virus is under control, the economic recovery will be uneven. The Bank of Canada notes that fiscal and monetary stimulus continues to be needed to support households and businesses. As part of projections assumptions, the vaccine role out proceed as has been announced and broad immunity is reach in advanced economies and China by the end of 2021 and in emerging-market economies (EMEs) in mid-2022.
Global Economy
The near-term outlook in many countries are constrained by the spread of COVID-19 and lockdowns. Policy continues to be essential to supporting households and business. Accommodative monetary policy remains in place in most advanced economies. Financial and commodity markets have reacted positively to vaccine arrival, and projections are for the pandemic’s direct effect to dissipate over the next two years. Global growth is projected to be 5.6% in 2021, 4.6% in 2022 and 3.9% in 2023. The global recovery benefits from the earlier than expected vaccine distribution resulting in less harm to potential GDP and a more certain trade environment with a new US administration and Brexit agreement.
Financial markets have risen since Fall 2020 with sovereign bond-yields continuing to be very low among advanced economies. However, US 10-year yields have risen 30 basis points reflecting expected inflation and inflation risk premium. The US dollar has depreciated amid the improving global outlook and risk profile.
In the United States, spreading COVID-19 and containment measures are limiting service consumption. However, housing, business investment and trade show relatively robust recovery. The job market was set back in December with job losses and unemployment remains elevated, including among long-term unemployed. Fiscal stimulus of US$900 billion has been agreed to and is likely to start impacting the economy in Q1 2021. Through 2021, fiscal stimulus, vaccine roll out, and accommodative financial conditions will support recovery in business and residential investment. The Bank of Canada projects growth in the US of 5.0% in 2021, 3.9% in 2022 and 2.0% in 2023.
Euro area growth declined sharply in Q4 amid virus resurgence and lockdowns. The recovery is expected to pick up in mid-2021 with easing of containment measures, vaccine distribution, and resolution of Brexit.
China’s economic recovery continues to pick up with consumption strengthening and expansions in industrial production, exports, and investment. China should benefit from stronger foreign demand and reduced trade tensions but will face higher oil prices and appreciation in the currency. Credit conditions have tightened following some corporate bond defaults.
Data for emerging-market economies has indicated robust recovery, reflecting less severe impacts of the virus than had been feared. Vaccine rollout is assumed to occur more slowly than in advanced economies.
Oil prices have moved higher since October and Canadian oil output has continued to recover, reflecting stronger global growth prospects. Supply reduction have also supported prices with Saudi Arabia cutting oil production for February and March 2021 and other countries maintaining production levels. Agriculture and base metals price indexes have risen since Fall with demand from China and forestry products rising on continued demand from the North American housing sector.
Canadian Economy
The resurgence of COVID-19 and containment measures have interrupted growth and imposed renewed hardships. Economic activity is expected to decline in Q1 2021, but to a less severe extent than the initial outbreak. The burden of lockdowns continues to be disproportional felt by workers and businesses in high-contact service sectors and many working parents, particularly women.
Over the medium term, consumption and employment will gain momentum as people are vaccinated. The economy will be supported with business investment and exports as uncertainity diminishes and confidence improves. Fiscal policy is expected to support growth into 2023 with additional stimulus of up to $100 billion announced in the federal Fall Economic Statement 2020. The medium-term outlook is stronger than previously expected with positive effects from vaccines, fiscal stimulus, foreign demand and commodity prices. Demand for housing has continued through the pandemic and housing activity should remain elevated amid low borrowing rates, resilient disposable income, and shifting preference for single-family homes. Canada GDP is projected to grow 4.0% in 2021, 4.8% in 2022 and 2.5% in 2023.
The weakness in early 2021 will make labour market conditions even more difficult while pandemic job losses of 640,000 (December 2020) have not been made up. Long-term unemployment rate has risen, risking skill erosion and labour market detachment. Some positive factors for the labour market have been from full-time employment and upward labour pressures in the goods sector. The Bank of Canada estimates the output gap to be between -3.75 and -2.75 percent in Q4 2020 – close to worst of the 2008-09 recession. The Bank of Canada notes that the pandemic will likely have lasting effect on potential output, but these cannot estimated with precision and may depend on how long behaviour changes last.
The easing of containment measure, returning consumer confidence, elevated levels of disposable income, and recovery in labour market should support consumption. Monetary policy is expected to support housing and durable goods purchases. Recovery in the hospitality and travel sectors is anticipated. The Bank of Canada assumes that households do not use elevated savings on consumption with nearly half of survey respondents in Q4 2020 planning on keeping most of their extra savings as a safeguard. Housing markets are expected to soften gradually from current elevated levels, but demand for single-family homes will outpace supply in 2021 before there is balance and softer price growth in 2022.
With a global recovery over 2021 and 2022, goods exports will benefit from rising foreign demand and face the headwind of an appreciated Canadian dollar. Service exports are expected to rebound strongly from low levels as travel restrictions are lifted but some business travel may not return as technology and behaviour changes could be permanent. Oil exports are expected to grow. Pipeline capacity is not likely to constrain exports in the near term but remains a risk in the medium term.
Excluding oil and gas sector, investment is expected to pickup in 2021 as uncertain wanes. Investments in digitalization, automation and e-commerce may speed up and be permanent – supporting spending in warehousing and equipment but not retail space.
Inflation projections reflect the dynamics of energy prices. Gasoline prices will temporarily lift inflation to be around 2% in Q2 2021 before inflation moves back to the lower half of the target range. Economic slack is expected to be the most important factor over medium term with an expectation that inflation will return to the 2% target as excess capacity is absorbed in 2023. The Bank of Canada projection for CPI inflation are 1.6% in 2021, 1.7% in 2022, and 2.1% in 2023.
Bank of Canada: Rate Announcement; Monetary Policy Report - January 2021
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