Bank of Canada Leaves Key Interest Rate Unchanged, Predicts Faster Economic Rebound

Summary

• The Bank of Canada had assured back in May that the policy interest rate will hold at 0.25 per cent until the economy heals from the COVID-19 impacts.
• Central bank governor Tiff Macklem is expected to hold a press conference on Thursday to speak on the rate interest decision.
• The latest report said that the bank will continue with its quantitative easing policy and purchase government bonds.
• As the economy reopens, the bounce back in third quarter activity will likely be faster than initially anticipated in July, said the BoC.

The Bank of Canada (BoC) has decided to leave the benchmark interest rate unchanged at 0.25 per cent on Wednesday (September 9) — a verdict that many financial analysts had foreseen, given the current economic status of the country. This is the third time since the pandemic led to massive market crash in March that the central bank of Canada decided to hold the benchmark interest rate steady.

In May this year, the central bank slashed its key interest rate from 1.75 per cent to 0.25 per cent to accommodate the severe contractions in the economy triggered by the pandemic. Later in July, BoC governor Tiff Macklem assured the public that the interest rate will remain near zero until the economic conditions improve, which experts believe could be at least 2023.

The Impact of COVID-19 Pandemic

The Bank of Canada, in its monetary policy report released in July, predicted that it will take till mid-2020 for the worst impacts of the pandemic on the Canadian economy to wear off. It had also said that the Bank will buy Canadian government bonds worth at least C$5 billion every week till improvement in the financial scenario is “well underway”. In Wednesday’s press release freezing the interest rate at 0.25 per cent, the Bank said that it will continue with this purchase.

The onset of the pandemic led to the economy hitting rock bottom in April, after the nationwide shutdown disrupted international trade, businesses and employment. Meanwhile, Canada’s real gross domestic product (GDP) saw a record dip at an annualized rate of 38.7 per cent in the second quarter of 2020, the sharpest dip in the Canadian economy since the initiation of the series began in 1961.

The Financial System Review 2020, which is a detailed analysis presented by the Governing Council of the Bank of Canada, assured that the big six Canadian lenders have sturdy capital and mortgage insurance system. Some experts also believe that having suffered and survived times like the Great Recession of 2008-2009 and the downturns of 1981–1982 and 1990–1992, Canada’s banking system is strong enough to weather the pandemic.

Despite the grave numbers, the GDP data for the second quarter of 2020 indicates that the recovery in the economy has been better than expected. The BoC, in its latest press report, predicted that the rebound in the third quarter could be faster than foreseen in its July report. It also said that with core funding markets performing well, there has been a drop in the usage of the BoC’s short-term liquidity programs.

Canada’s Inflation Levels

Statistics Canada report of the second quarter GDP showed a record 13.1 per cent drop in household spending. This was an obvious after-effect of job loss, closure of non-essential businesses and people tending to limit their expenditure to necessities amid the pandemic. According to the central banks’ July monetary policy report, the drop in the prices of goods and services that were no longer in demand, such as gasoline, conveyance, clothing, etc, exceeded the rise in prices for products that were in high demand, like food items, cleaning products, etc. This caused a sharp dip in the Consumer Price Index (CPI), causing inflation to fall near zero in the April-May period.

The CPI inflation is still close to zero, says the central bank, and the fall in the prices of energy and travel services is pressing down upon the inflation. Meanwhile, its core inflation measure ranged between 1.3 percent and 1.9 percent in the August-September period.

The BoC expects this fall in prices to press down inflation till early 2021. After that, depending on the rate at which business recovers, there is a chance of a muted inflation.

High Fiscal Deficit

The Bank of Canada took many policy measures, such as deferred payments on mortgages and loan balances, to ease the pressure of the pandemic on people. Canada’s fiscal deficit also saw a record high ofover C$ 343 billion in its bid to accommodate the COVID-related support programs.

Before his exit from the Cabinet, former Finance Minister Bill Morneau and Prime Minister Justin Trudeau is said to have butted heads over the latter’s coronavirus-related policies and the rising deficit it was adding to. Trudeau’s push for environment-friendly projects in the 2021 budget and the Ottawa government’s expenditure on COVID-related programs had also faced a pushback from Morneau.

While the government’s spending offers support to the people through the COVID-19 crisis and helps the economy heal, experts feel that it will also expand the already-high deficit.

Prorogation of the Parliament

Shortly after the swearing-in of Finance Minister Chrystia Freeland last month, Prime Minister Trudeau announced the prorogation of the Canadian Parliament until September 23. He later denied media speculation that this decision was taken to cause an election in October.

A prorogation essentially means that bills that are in the pipeline expire, although they can be started again later. When Trudeau called to prorogate the Parliament, the decision was met with much pushback as many COVID-related programs were still in the pipeline. Some reports said that the Prime Minister made this move in order to cover up the WE Charity scandal.

Trudeau, in the wake of the announcement, said it was not a responsible move to go on with the government's recovery plan regarding the pandemic without the House of Commons’ approval. However, he also told the reporters that a hike in interest rates is the “last thing Canadians need”.