Photo by Jason Hafso on Unsplash

Today’s announcement by the Bank of Canada to hold the line on its policy rate is disappointing to the Canadian banking community that was looking for a clear sign that rates would start their long upward march. The media was rife with warnings to consumers, mortgage borrowers, and businesses to expect the BoC to start hiking rates, especially given the inflationary surge of the past few months. Simply, the clarion call went out that the BoC needs to act to curb inflation. 

Nonetheless, the BoC took the right stance in today’s announcement by recognizing the great uncertainty that plagues (excuse the pun) central bankers in trying to map future monetary policy. From today’s statement, the BoC is very mindful of the toll that Omicron has taken so far and, more importantly, the risks that it will continue to impact negatively. To wit,

“In Canada, GDP growth in the second half of 2021 now looks to have been even stronger than expected. The economy entered 2022 with considerable momentum, and a broad set of measures are now indicating that economic slack is absorbed. The Omicron variant is weighing on activity in the first quarter. While its economic impact will depend on how quickly this wave passes”.

On the inflation front, the BoC is on the side of those who expect the inflation rate to diminish steadily and ultimately ease into the BoC target range of 2% by 2023. According to the BoC:

“CPI inflation remains well above the target range and core measures of inflation have edged up since October. Persistent supply constraints are feeding through to a broader range of goods prices and, combined with higher food and energy prices, are expected to keep CPI inflation close to 5% in the first half of 2022. As supply shortages diminish, inflation is expected to decline reasonably quickly to about 3% by the end of this year and then gradually ease towards the target over the projection period. Near-term inflation expectations have moved up, but longer-run expectations remain anchored on the 2% target.”

Long-term interest rates have barely budged of late, an indication that real long-term rates will remain clearly in negative territory. Bond investors share the view that prices will moderate and over time deflationary forces will prevail. Late last year, the BoC announced that it would no longer participate in the purchase of more government bonds, however, it is not yet prepared to reduce its balance sheet, to wit:

“The Bank will keep its holdings of Government of Canada bonds on its balance sheet roughly constant at least until it begins to raise the policy interest rate. At that time, the Governing Council will consider exiting the reinvestment phase and reducing the size of its balance sheet by allowing roll-off of maturing Government of Canada bonds.”

Finally, the BoC concedes that it no longer feels the need to hold its policy rate at the effective lower bound and that rates “will need to increase”. But the key consideration concerns “the timing and pace of those increases guided by the Bank’s commitment to achieving the 2% inflation target”. Determining “timing and pace” is a tall order.