Bank of Canada keeps benchmark rates intact, says full economic recovery unlikely before 2022

Summary

• The Bank of Canada will maintain its current level of policy rate until inflation objective is achieved and will continue the program of quantitative easing by buying Canadian government bonds
• The central bank predicts that the national economy will shrink by almost 8 percent this year, then grow by just over 5 percent in 2021 and nearly 4 percent in 2022.
• The economic growth will not return to pre-COVID levels until 2022, based on assumption there is no second wave or flare-up of the virus

The Bank of Canada will maintain its current benchmark interest rate until the “two percent inflation target is sustainably achieved”, said central bank Governor Tiff Macklem while discussing the Monetary Policy Report (MPR) in a teleconference on Wednesday, July 15. The key interest rate has been at 0.25 percent since March this year after the pandemic triggered an economic recession and market crash.

The economic growth will not return to pre-COVID levels until 2022, said the central bank in its updated quarterly outlook. It expects Canada’s real gross domestic product (GDP) to decline by 7.8 percent in 2020, driven down by a year-over-year contraction of 14.6 per cent in the second fiscal quarter. Economic growth will touch 5.1 percent in 2021 and 3.7 percent in 2022, added the policy report.

The central bank will continue its quantitative easing (QE) program, buying at least C$ 5 billion per week of Government of Canada bonds until the recovery is “well underway.”

Both Governor Macklem and central bank’s Senior Deputy Governor Carolyn A. Wilkins emphasized that the Canadian outlook is “extremely uncertain” and projections are based on three key assumptions:

1. i) There is no second wave or flare-up of the coronavirus,
2. ii) Large-scale containment measures are slowly lifted, and

iii) The pandemic will be contained by mid-2022 over the likelihood of availability of vaccine or treatment.

Given the unpredictability of the course of the COVID-19 pandemic, “a central scenario is provided rather than a projection,” states the MPR.

Canada faced “historic drops in economic activity in the first half of the year and it will be long climb out,” said Governor Macklem. He maintained that interest rates will be unusually low for a long time.

A sharp rebound is expected in economic activity during the reopening phase of the recovery, followed by a prolonged recuperation phase, which will witness a bumpy journey across regions and sectors.

Chart: The recovery in economic activity and household spending follows two phases - reopening and recuperation (Source: Bank of Canada)

Predicting an extended period of difficulty for workers and businesses, the central bank added that precautionary physical distancing will continue to restrain overall household spending even after lockdown restrictions are completely lifted.

The human and economic losses would be worse if containment measures didn’t succeed in flattening the curve, added the central bank.

Other highlights from the Bank of Canada’s policy report is as follows:

• Global economic activity is picking up after a sharp drop in the first six months of 2020, reflecting a relaxation of lockdown measures combined with fiscal and monetary policy support.
• Canada’s economic activity contracted by 15 percent in the second quarter as compared to the end of 2019, marking the deepest decline since the Great Depression of 1930s.
• Early signs show initial rebound in employment and output due to pent-up consumer demand and reopening of businesses.
• CPI inflation dropped to negative 0.4 percent in May due to sharp fall in costs of gasoline, travel services, etc.
• The central bank’s core measures of inflation (CPI trim, CPI median, CPI common) have also come down, and hover between 1.4 and 1.9 percent.

Summary of Projection for Canada (YoY percentage change)

The next interest rate announcement will be on September 9, 2020.

The unprecedented coronavirus pandemic caused the Canadian economy to hit rock-bottom in April, with three million jobs lost. As of July 23, Canada has a total of 112,240 coronavirus positive cases, 98,142 recoveries and 8,870 deaths.

The lockdown imposed to contain the virus has disrupted the flow of the economy. Some employees shifted to remote work models. Others, including the service sectors such as travel, hospitality, and personal care services, took a major hit.

The country’s fiscal deficit spiked to C$ 343.2 billion – levels not seen since the second world war – as the federal government increased expenditure on coronavirus-related support programs.

Direct support to individuals and businesses by the federal government touched C$ 212 billion this year, much of which will be financed through a new bond programme.

The pandemic-induced economic contraction, and subsequent recovery will be very different from a typical business cycle, said the central bank.