We anticipate that the Bank of Canada will maintain its overnight target rate of 0.25% and retain its current policy of accommodation in its announcement on Wednesday.
The RSM Canada Financial Conditions Index points to improved risk appetite as the economy emerges from its yearlong slumber.
Expectations are that the effects of the pandemic will have dampened economic growth during the first quarter of this year, even as a successful distribution of vaccines is creating the conditions for a broad-based economic recovery this year.
In addition, an unemployment rate of 9.4% implies a labor market with a long road back to full employment. With an inflation rate near the bottom of the central bank’s target range of 1% to 3%, implying a lack of demand, the Bank of Canada is going to be patient on the path of monetary policy as the economy heals.
That said, our proprietary RSM Canada Financial Conditions Index stands at 1.38 standard deviations above neutral, which implies that financial conditions are conducive to economic activity and a solid recovery this year. That improvement in financial conditions is linked, to a degree, to rising oil prices.
Excluding oil and energy prices, the index stands at 0.4 standard deviations above neutral. For this reason, the Bank of Canada should remain accommodative to ensure that the improvement in the energy-based economy is matched by gains in the domestic real economy.
Containment of the pandemic among Canada’s major trading partners and rising expectations for global growth and infrastructure investment point to an economic revival in the near term.
The RSM Canada Financial Conditions Index measures the degree of risk and accommodation priced into financial assets.
Because central banks have determined that monetary policy is transmitted to the economy via financial conditions, we have created the RSM Canada Financial Conditions Index to measure the degree of risk and accommodation priced into financial assets.
That index points to improved risk appetite as the economy emerges from its yearlong slumber.
Since the pandemic began, the Bank of Canada has worked to maintain liquidity in the money markets necessary for day-to-day commerce, and to incentivize investment by suppressing long-term interest rates, which lowers the cost of capital. This is evident in the normalization of financial conditions that began last summer.
In Canada’s financial markets, the degree of accommodation is now at 1.38 standard deviations above normal, and looks to be approaching levels that might otherwise suggest an asset bubble.
In ordinary times, we might expect the Bank of Canada to begin applying the brakes on an overheating economy and begin raising interest rates. But these are not normal times, and the current conditions do not imply that a financial bubble has formed.
Because of the role of resources in Canada’s economy and in the value of the Canadian dollar – similar to Australia and New Zealand – we included commodity prices in our RSM Canada Financial Conditions Index. And though we would expect commodity prices to rise along with the uptrend in demand during an economic recovery, there has been an exogenous factor during this business cycle.
Crude oil production cuts by OPEC were introduced last April as the demand for energy plummeted during the economic shutdown and then continued as consumers reduced travel and cut down on ordinary driving routines.
In recent days, OPEC has agreed to continue limiting production until the global economic recovery and increased demand for energy look to be sustainable.
Eliminating commodity prices from our calculations suggests that financial conditions are only 0.4 standard deviations above normal. Because of the artificially induced benefits to the nominal value and growth of Canada’s gross domestic product caused by the increase in a barrel of crude oil, we expect the Bank of Canada’s policy to remain where it is.
It will take more than one quarter and one commodity to return Canadian unemployment and inflation back to normal.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
