Tiff Macklem’s first press conference and Monetary Policy Report as Bank of Canada Governor went without a hitch today, mainly because nothing was really announced.
Forward guidance was what the market wanted coming into this monetary policy meeting and with the MPR shifting from two illustrative scenarios to a central scenario more akin to point forecasts, the chances of substantive forward guidance being delivered at this meeting was as high as we’ve seen since the outbreak of the pandemic. However, despite the BoC putting numbers to a base case growth and inflation forecast, forward guidance was limited to “the Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved”. This was reiterated by both Governor Macklem and Senior Deputy Governor Wilkins throughout the press conference too, but as a measure of forward guidance it is as effective as saying “how long is a piece of string?”.
There are multiple reasons for this. Firstly, to estimate when economic slack, or the output gap as Macklem rephrased in the presser, has diminished, we need a forecast on potential growth. The Bank of Canada has extended its estimates of potential output from its January MPR by one extra year until 2022 to address this. The problem arises in the sense that the economy is unlikely to exit the pandemic resembling how it went in it, rendering the potential growth forecasts redundant. Secondly, for it to give a semblance of forward guidance, the Bank needs to provide an accurate and confident projection for real growth and thus the shape of the recovery. While markets received a central scenario, the risks surrounding it were still plentiful and tilted to the downside. Finally, inflation. While Macklem reiterated that the Bank would continue to target headline inflation, Box 2 in the MPR highlighted the shortcomings of the current headline CPI index, which has increasingly underreported inflation pressures that the consumer is facing on the ground since the outbreak. Governor Macklem highlighted this in the press conference, stating that Statistics Canada are willing to adjust the consumer basket more frequently than seen in the past to reflect changing consumer preferences as measured by high-frequency expenditure data. This is all well and good and helps explain why inflation expectations are relatively unchanged as the headline CPI data nosedives, but presents a moving target for markets to formulate monetary policy expectations.
The underwhelming guidance given in the opening statement and the MPR was best highlighted by the loonie. The Canadian dollar barely flinched at the additional information provided by the central bank, instead rallying off the back of falling US crude inventories at 10:30 ET.
While we understand why the Bank of Canada opted to remain relatively vague with details of forward guidance, instead retaining optionality for policy setting, it does little in assisting financial markets in pricing policy expectations at a time when issuance is set to rise substantially. By taking this stance today to avoid cornering policy during a period of heightened uncertainty, evidenced in the decision to keep the minimum purchasing rate at C$5bn a week as we expected, the BoC may have to pay the price in the bond market. This could take the form of increased near-term purchases, extending the length of its QE programme, having to purchase more longer-dated debt, or a blend of all of the above. One thing is for sure, we just won’t know until it happens.
For now, markets will have to continue taking it day-by-day, auction-by-auction, as one vague statement in the form of the “deep hole” comment is replaced by others such as “economic slack absorbed”, “recovery well underway” and “inflation is sustainably achieved” when the basket is being consistently adjusted.
This is a tough time to be a central banker and on the whole we do believe the BoC has taken the right approach in response to the pandemic.
The lower rates for longer playbook seen in Carney’s era is being rolled back out again, but forward guidance on the LSAP programme will be needed at some point down the line. The loonie extended its gains throughout the press conference as the Bank’s decision to not increase the minimum purchasing amounts and
even discuss further loosening measures such as negative rates can be taken as relatively hawkish in the current environment.
Further details of the BoC meeting:
- Rates were kept at 0.25% with LSAP purchasing rate kept at a minimum of C$5bn a week. Government of Canada debt will be purchased across the curve in line with outstanding debt and issuance, highlighting a potential shift towards purchasing longer-dated Canadian bonds.
- Q2 economic activity 15% below Q4 2019 level, with the central scenario assuming 40% of lost activity will be recouped in Q3.
- GDP set to decline 7.8% in 2020, then rise by 5.1% in 2021 and 3.7% in 2022.
- The Bank of Canada expected economic slack to persist as the recovery in demand lags than of supply. The estimated lag is around 6-7%.
- CPI expected given the current basket to return close to the 2% target at the back-end of 2022, with the central scenario based upon; WTI and WCS at $40 and $30 respectively, USDCAD at $1.3510, A neutral interest rate of 2.5% and to be reassessed in October’s MPR, no broad-based second wave in Canada or internationally, most large scale containment measures to be eased gradually and the pandemic to be largely done by mid-2022 due to the wide access of a vaccine or effective treatment.
USDCAD falls 0.7% towards lower bound of recent range as BoC’s decision to not inject more monetary stimulus is taken as net hawkish
Economic recovery towards potential output and shifting CPI basket
Central scenario economic projections
Author: Simon Hervey, FX Market Analyst