Bank of Canada signals record low rates here to stay until 2023
28 Oct 2020
The Bank of Canada is setting up to run a high-pressure economy until at least 2023, a delicate operation that will require a lot of tinkering along the way.
Governor Tiff Macklem and his five advisers on Governing Council reiterated their commitment to ultra-low interest rates for an unusually long period this week. But they made some adjustments, including a more explicit timeline for how long they plan to keep the benchmark rate at 0.25 per cent, which is as low a policy-makers think it can go without unduly disrupting the financial system.
They also rejigged their bond-buying program, saying they will favour Government of Canada bonds with longer maturities, an acknowledgement that the central bank — in its fervour to avoid a depression this spring — might have been inadvertently depriving private investors of popular, low-risk securities that allow financial markets to function smoothly.
“As the economy recuperates, it will continue to require extraordinary monetary policy support,” the Bank of Canada said in a statement on Oct. 28.
The previous commitment — made in July after Macklem oversaw his first round of policy deliberations as governor — was to keep the central bank’s key interest rate pinned near zero until the two-per-cent-inflation target was “sustainably achieved.” Forecasts indicated that meant the benchmark rate would remain at a record low for at least a couple of years, and Macklem said as much in a television interview with BNNBloomberg at the time.
Policy-makers decided there was value in removing whatever ambiguity remained around their intentions, betting that by erasing the risk of a surprise spike in borrowing costs down the road, they will be able to induce more executives and households to borrow money to invest and spend. They said concretely in the new policy statement that their current forecasts suggest that they won’t reach their inflation goals “until into 2023,” giving the public something it can put in a calendar.
The central bank released a glum economic outlook.
Gross domestic product grew at an annual rate of almost 50 per cent in the third quarter, much faster than the rate of about 30 per cent that the Bank of Canada predicted in July. But growth decelerated dramatically as the economy entered what the Bank of Canada is calling the “recuperation phase” of the recovery from the COIVD-19 crisis. Its new forecast predicts an annual growth rate of only one per cent this quarter, and assumes that GDP won’t return to pre-pandemic levels until 2022.
“The economic recovery is projected to be prolonged, underpinned by policy support but largely influenced by the evolution of the virus, ongoing uncertainty and structural changes to the economy,” the Bank of Canada said in its fall Monetary Policy Report. “These changes could result in longer-term shifts of workers and capital across different regions and sectors of the economy. This adjustment process weighs on the bank’s estimates of potential growth.”
The central bank’s updated estimates of potential growth — its best guess on how fast the economy can expand without putting too much upward pressure on inflation — show that the legacy of the pandemic will extend well into the future. The scarring effects of extended unemployment and depressed business investment forced the Bank of Canada to drop its estimate of potential output to 0.9 per cent in 2021 and 1.1 per cent in 2022, compared with previous estimates of 1.8 per cent and 1.9 per cent, respectively.
Eventually, those weaker estimates of potential growth could constrain the Bank of Canada’s ability to keep interest rates low, because inflation will heat up more quickly in an economy that has reduced capacity to keep pace with demand. That’s not a problem the central bank foresees for a few years, however, as it predicts the Consumer Price Index still will be below two per cent at the end of 2022, a testament to the size of the hole that was created by the initial lockdowns to slow the spread of the coronavirus.
