An improved economic outlook and growing confidence among central bankers have created the conditions in which the Bank of Canada is now comfortable paring back the pace of bond purchases by $3 billion per week.
The central bank’s announcement on Wednesday represents a slowing in the pace of accommodation, and in our view it is a prudent step to take as the economy will most likely expand at a 6% rate this year as inflation moves back above 2% by the end of the year.
In our estimation, the policy move today should be tempered by the recent intensification of the pandemic and challenges in increasing the pace of vaccinations that in the near term pose some downside risk to our forecast of a 6% pace of economic expansion this year.
In addition, the central bank is positioned to look through the coming increase in inflation, which the bank estimates will move toward the top of its 1% to 3% range.
Despite the recent flareup in the pandemic, the Bank of Canada pulled forward its estimation of when the economy will move back to pre-pandemic production, to the second half of 2022. Although this will tempt some to begin talking about pulling forward the timing of the first rate hike into the second half of 2022, we do not see that as the likely course of policy at this time.
Rather, we think that the output gap in the economy through the end of last year stood at 5.1%, well below where the U.S. is at the current time.
The Organization for Economic Cooperation and Development estimates that the Canadian economy, even with a strong economic rebound, will still be 3.2% short of what constitutes full production at the end of this year. Central bankers will almost surely seek to manage expectations around the timing and magnitude of monetary policy normalization.
Moreover, with the unemployment rate still elevated at 7.5% and likely to decline to 6.8% by the end of the year, the central bank is well positioned to retain an accommodative position and focus on full employment as a key metric for the timing of a change in policy.
The notation inside the monetary policy report of the difficulties of interpreting economic signals including a range of labor market measures is the primary takeaway underscoring the bank’s overall dovish outlook despite the pulling back in the pace of asset purchases.
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