July 14, 2021 | 11:08
BoC Walks the Walk on Taper Talk
The Bank of Canada largely stuck to the script in its latest policy decision by keeping rates steady, announcing a further reduction in QE, and still looking for the output gap to close by the second half of next year. After a surprisingly hawkish fusillade in April, today's set of announcements was much less market moving, with the Bank offsetting its mostly sunny outlook with some notes of caution and/or uncertainty. That theme of optimism couched with caution was repeated in the Governor's opening statement ahead of his press conference.
The most significant step today was another tapering of the QE program to $2 billion per week (from $3 billion). As was the case in April, the Bank pulled no punches on why it was taking this step: "This adjustment reflects continued progress towards recovery and the Bank’s increased confidence in the strength of the Canadian economic outlook."
The quarterly Monetary Policy Report's latest economic forecast was a touch more cautious than the April effort for this year because of the third-wave restrictions (trimming GDP to 6.0% from 6.5%, moving in line with us), but is now on the upbeat side of the ledger for the next two years (they boosted 2022 to 4.6% from 3.7%, again almost exactly in line with our call). The Bank also cranked its inflation forecast for this year and next, but is still a bit below our current view.
Taking these growth revisions together leaves the level of GDP higher by the end of next year. Even so, the Bank continues to see economic slack being taken up by the second half of 2022, albeit with a great deal of uncertainty around that forecast. In a similar vein, the Bank very much buys into the transitory view on the run-up in inflation (even borrowing the Fed's terminology), but readily allows that forecasts around the output gap, and thus inflation, are "highly imprecise". We lean to the more-than-transitory view.
A few quick highlights and the Bank's views:
On housing: "Housing activity is anticipated to remain higher than it was before the pandemic even as it declines from its recent record-high levels. The recovery in employment, increasing population growth and elevated savings support the projection for housing demand." While activity is cooling here, it won't reverse all of the huge gains in the past year.
On labour scarring: "The uniqueness of the pandemic may mean that the length of time unemployed is a less reliable indicator of scarring risks. The workers most affected by the pandemic—namely, young people and workers with fewer skills—may face less risk of skills erosion." The Bank sounds less concerned on this front.
On the currency: "The Canada-US exchange rate is little changed since April." Nothing to see here folks...literally.
On the global economy: "The recent spread of new COVID-19 variants is a growing concern, especially for regions where vaccinations rates remain low. Global GDP growth is expected to reach 7 percent this year and then moderate to about 4 ½ percent in 2022 and just over 3 percent in 2023. This a slightly stronger forecast than the April MPR." Even while raising the global outlook, the Bank begins by sounding a note of caution on the recent upswing in cases in many jurisdictions (but not so in Canada).
Bottom Line: The Bank made few waves with its latest policy announcement and quarterly forecast, mostly landing right in line with consensus on almost all fronts (for a change). We expect the tapering process to continue apace, with the Bank winding down its QE by early next year. This will set the stage for rate hikes, likely within the next 12 months of the end of QE, with a good chance of sooner rather than later. The "later" risks would be driven by the virus, while the "sooner" risks could arise if inflation remains stubbornly high and/or if growth is juiced more than expected by well-supported consumers.
Overall, while the perception is that the Bank is quite hawkish, especially compared with the Fed, we ultimately expect very little daylight between the two banks when it comes to rate hike timing. After all, the Canadian economy took a deeper hit in the past year, has more ground to make up, and is dealing with less frothy inflation than the U.S., partly due to a strong currency—hardly a recipe for a much more aggressive policy.