The Bank of Canada maintained its overnight rate at 0.25 per cent this morning, a level it considers its effective lower bound. The Bank reiterated what it calls "extraordinary forward guidance" in committing to leaving the overnight rate at 0.25 per cent until slack in the economy is absorbed and inflation sustainably returns to its 2 per cent target. The Bank projects that will not occur until 2023. The Bank is also continuing its quantitative easing (QE) program, purchasing at least $4 billion of Government of Canada bonds per week. In the statement accompanying the decision, the bank noted that while the near-term outlook for growth is strong, there remains considerable slack in the economy and employment is still well below its pre-COVID levels. Inflation is expected to move modestly higher, largely reflecting base-year effects and deep price declines in some goods and services at the start of the pandemic.
The Bank of Canada was anticipating a second wave induced contraction of the economy in the first quarter of this year and so finds itself somewhat caught off guard by a vastly improved economic outlook and rising long-term bond yields. The massive $1.9 trillion COVID-19 relief package, the American Rescue Plan, recently passed by the US Congress and good news on the speed of US vaccinations has prompted a re-set of expectations in financial markets as higher economic growth and inflation gets priced into bond yields. While the Bank has continued its quantitative easing program aimed at holding Canadian long-term interest rates down, there is little it can do to combat the pressure on the Canadian yield curve from rising US long-term interest rates. Recognizing the much brighter economic outlook, the Bank may announce a tapering of its QE at its next meeting in April but will stick to its commitment to keep its policy rate on hold until 2023. That would mean a widening gap between fixed and variable mortgage rates over the next year as fixed mortgage rates rise alongside long-term interest rates.
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