The emerging trend of central banks talking like hawks and walking like doves amid supply chain disruptions and persistent inflation continued as the Bank of Canada kept its policy rate at 0.25% on Wednesday.
The central bank signaled that it intends to end its quantitative easing program.
The central bank signaled that it intends to end its quantitative easing program and move toward the reinvestment of proceeds from maturing assets while implying that the inevitable rate tightening could start as early as the middle of next year.
Caught amid a significant disruption of global supply chains, rising commodity prices and inflation, the central bank mapped out a policy path that implied more hawkish rhetoric around pricing to keep inflation anchored even as it maintains an accommodative monetary stance.
In addition, the Bank of Canada took care to note in the policy paragraph of its statement that the economy requires considerable support and that it is committed to holding the policy rate at the effective lower boundary until economic slack is absorbed.
Our interpretation of that guidance is that the market may be getting ahead of itself with respect to the pricing in of three rate hikes through next September.
We urge caution in overinterpreting moves in a thin and illiquid market as the updated forecast from the central bank implies slower growth ahead even as the economy closes the output gap in the second half of next year.
The Canadian economic recovery remains incomplete compared to the pre-pandemic growth trend.
The Canadian economic recovery remains incomplete compared to the pre-pandemic growth trend as wage pressures remain in check and inflation expectations are solidly well anchored.
The forecast embedded in the policy statement implies that the Canadian economy will grow at 5.1%, down from a previous estimate of 6%, and then expand by 4.3% next year and by 3.7% in 2023.
Within this forecast it is possible that the output gap could close by the end of the second quarter of next year. Inflation is now projected to increase at 4.8% this year and slow to 2.1% near the end of next year.
Should inflation evolve toward the central bank’s forecast next year, the Bank of Canada will have plenty of policy space to respond to any exigent circumstances and sufficient degrees of freedom to keep the policy rate in place or raise it.
The ending of its quantitative easing program implies that the central bank is preparing to shift its policy toward the reinvestment of proceeds from maturing assets on its balance sheet and will not engage in a tightening until it is satisfied with the diminishing of economic slack.
Those market expectations that imply three rate hikes over the next year may be somewhat excessive given the underlying caution of a central bank that continues to walk a fine line between hawkish rhetoric and dovish actions.
