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Summary
- Bank of Canada announced will keep its overnight rate steady at 0.25 per cent until the inflation target of 2 per cent is achieved
- Since March 27, the policy interest rate of 0.25 per cent continues to remain unchanged.
- The central bank predicts the Canadian economy will shrink by 5.5 per cent in 2020 and grow by almost 4 per cent in 2021 and 2022.
The Bank of Canada announced that it will keep its overnight rate steady at 0.25 per cent until the inflation target of 2 per cent is achieved, which is unlikely before 2023, it added. The bank rate will be 0.5 per cent and the deposit rate is 0.25 per cent.
Cheap lending is the need of the hour for industries and businesses to recover from the Covid-19 impact, said Governor Tiff Macklem. This is the cheapest rate the bank could offer without disrupting the system, he added. With overnight lending rate, the depository institutions can access short-term financing and overcome liquidity constraints.
The central bank will continue its quantitative easing policy of buying government bonds to suppress the costs involved with long-term borrowing until recovery is “well underway”.
At the onset of the pandemic, the bank reduced its policy interest rate from 1.75 per cent in January 2020 to 1.25 per cent at the beginning of March, down by 0.5 per cent. In mid-March, the interest rate was reduced by 0.5 per cent again to arrive at 0.75 per cent. This was further reduced to 0.25 per cent towards the end of March and has continues to remain unchanged.
The central bank predicts the Canadian economy will shrink by 5.5 per cent in 2020 and grow by almost 4 per cent on an average in 2021 and 2022. Inflation, however, is expected to be below its 2 per cent target in the next two years. These projections are made by the Bank of Canada assuming no Coronavirus-led lockdowns is reimposed in the future, and a vaccine will be available by mid of 2022.
In September, the inflation stood at 0.5 per cent and this figure is expected to stay in range of 1 to 3 per cent until next year, owing to economic slowdown and low energy prices.
The Canadian economy rebounded in the third quarter, but the problem of job loss lingers, particularly affecting the lower-wage income workers in certain sectors where social distancing is almost impossible to achieve. The reopening phase characterised by rapid growth is over, said the central bank. We are now in the recuperation phases, wherein income support programs from the federal government and Bank of Canada will continue to support, it added.
The central bank also said that the growth patterns will continue to remain choppy because of second wave of Covid-19 outbreak, containment measures and varying rates of recovery across business sectors.
Understanding BoC’s Move
In times of slow economic growth, the central bank generally brings down the overnight rate to facilitate ease of borrowing at a lower rate. Subsequently, this relief is passed on to the customers at lower interest rates. This makes loans more affordable for businesses and individuals. As businesses secure funds for investment and expansion activities, the purchasing power of consumers also increase.
While the Bank of Canada can set an overnight rate, it is not required of all banks operating under its jurisdiction to charge the same rate for overnight lending activities. The rates can differ and vary from bank-to-bank participating in the overnight market.
At the outset of the pandemic, bonds with shorter maturities were bought wherein issuance was the strongest, however now since the markets are doing well, the focus has shifted towards bond purchases with longer maturities. The central bank is recalibrating its Quantitative Easing (QE) program to shift focus toward long-term bonds.
Longer maturity bonds increase the amount of monetary stimulus as it is directly focused on borrowing rates relevant for businesses and households. Considering the impact of long-term maturity bonds, the Bank of Canada will be reducing its weekly bond purchases from C$5 billion currently to C$4 billion.
PM Justin Trudeau-led Canadian government projected a fiscal deficit of C$343.2 billion in July, as the federal expenditure on coronavirus-related programs spiked. This is almost equivalent of 16 per cent of the country’s economic output.
Towards September-end, parliamentary budget officer (PBO) Yves Giroux said that the country’s budget deficit will hit C$328.5 billion in the 2020/21 fiscal year. The independent budgetary watchdog claimed that the double whammy of the pandemic and sinking oil prices may leave a “permanent” mark of the Canadian economy.
