October 28, 2020 | 11:10
BoC: The Year of Forecasting Dangerously
The Bank of Canada kept interest rates unchanged at today's decision, in line with expectations, but there was a twist in their bond-buying program. The Bank was at pains to stress that the adjustments maintained the same high degree of stimulus, but they announced that they will gradually scale back the pace of weekly bond buying to $4 billion (from $5 billion), while at the same time extending the term of those purchases. The Bank explained that, compared to other central banks, their bond buying had been heavily tilted to short-term bonds, and they will now concentrate more on longer-term bonds (the "twist"), which they believe will offset the slightly smaller scale of net buying. This is a mild surprise, since most expected that, with COVID clouds menacing the near-term outlook again, the Bank would not want to even hint that they were scaling back support—hence, the up-front message that the package of measures doesn't move the dial on stimulus.
In general, today's Statement had to walk a fine line—noting the better-than-expected economic outcome in the rear-view mirror, but also recognizing the rapidly darkening skies immediately ahead. The overall tone of their remarks was quite cautious, and drove home the point that the economy would require heavy-duty monetary and fiscal policy support for quite some time yet. The Bank repeated that its explicit commitment to keep rates unchanged until the output gap closed and inflation returned to 2%, but added a timeframe of 2023 at the earliest. That's a pretty clear message, if not quite a direct forecast on rates.
The Bank's latest quarterly Monetary Policy Report was perhaps most notable for its updated forecast. On that front, the Bank moved almost entirely in line with consensus, for nearly every economy. (In the July MPR, the Bank had been more than percentage point weaker than consensus on Canada, and was miles below on the U.S. call, where they have ramped up this year's GDP estimate by a whopping 4.5 ppts.) Given the rapid run-up in virus cases in recent weeks in many key economies, and renewed restrictions in many areas, it's a bit surprising that the Bank didn't remain a bit more cautious relative to consensus, frankly. The Bank has allowed for a marked cooling in activity, looking for just 1.0% growth in Q4 after the 47.5% sprint in Q3. While they have heavily revised this year's call to nearly in line with ours at -5.7% (from -7.8% in July), the Bank also cut next year's estimate by just over 1 ppt. Less of a drop, less of a rebound.
Beyond the short-term forecast change, the Bank also made two very important adjustments in the MPR on its medium-term assumptions—for potential economic growth, and on the neutral interest rate. In both cases, not surprisingly, the adjustments were lower. On potential, growth was chopped by nearly a percentage point per year over the forecast horizon, both due to a wounded productivity outlook and lower labour force growth rates. For example, next year's mid-point estimate was cut to just 0.9% from 1.8%. With a more subdued trend growth rate, this helped explain one of the reasons why they cut the estimate on neutral interest rates by a full 50 basis points to a range of 1.75% to 2.75%. Let's just say that this adjustment was a long time coming, since rates never got above 1.75% at the height of the prior cycle. Arguably, the new range for "neutral" is still a bit high.
Some key highlights from the Statement included
"The Bank is recalibrating the QE program to shift purchases towards longer-term bonds, which have more direct influence on the borrowing rates that are most important for households and businesses. At the same time, total purchases will be gradually reduced to at least $4 billion a week. Governing Council judges that, with these combined adjustments, the QE program is providing at least as much monetary stimulus as before." ..... No details are available yet, but the message is quite straightforward on this adjustment to QE.
"Growth will likely be choppy as domestic demand is influenced by the evolution of the virus and its impact on consumer and business confidence. Considering the likely long-lasting effects of the pandemic, the Bank has revised down its estimate of Canada’s potential growth over the projection horizon." .... With so much focus on the near-term impact of the virus, it's easy to overlook the possibility of longer term effects on the economy, and the Bank believes there will be lasting impacts. Fundamentally, this is (yet another) reason to believe rates will remain low for longer.
Bottom Line: The Bank of Canada asserts that it is maintaining its ultra-high degree of monetary stimulus, even with the tweaks to the bond buying program, and fully expects to remain in this pedal-to-metal mode at least until 2023. After a tumultuous spell for all forecasters, the Bank's view on the economy has largely moved into line with consensus. And the main message there is that growth will be put on hold in Q4 by the second wave, but it won't go into reverse, and should resume in 2021.