The Bankwatch

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Bank of Canada sees economy shrinking 7.8% this year; holds rates steady


Bank of Canada sees economy shrinking 7.8% this year; holds rates steady

The Bank of Canada projected that the Canadian economy will shrink by 7.8 per cent this year, as it crawls its way out of the deep hole of the COVID-19 crisis.

The forecast, the central bank’s first in six months, came as the bank announced its latest policy decision, holding its key interest rate steady at a record-low 0.25 per cent and leaving its large-scale bond-purchase programs unchanged. The bank reinforced that it intends to keep both policies in place far into the economic recovery.

“The Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 per cent inflation target is sustainably achieved,” it said. “In addition, to reinforce this commitment and keep interest rates low across the yield curve, the bank is continuing its large-scale asset purchase program at a pace of at least $5-billion per week of Government of Canada bonds.”

In its quarterly Monetary Policy Report (MPR) Wednesday, the central bank estimated that the Canadian economy lost “about 15 per cent” of its economic activity in the second quarter compared with end-of-2019 levels, as containment measures for the pandemic were at their height. However, it noted encouraging signs of a rebound now under way, with economies reopening in Canada and many other parts of the world.

The bank estimated that real gross domestic product plunged 13.1 per cent in the second quarter, on top of a 2.1-per-cent contraction in the first quarter. It said it expects a bounceback of 7.1 per cent in the third quarter, reflecting the rapid return of activity as containment restrictions continue to be lifted. The forecast assumes that “about 40 per cent” of the drop in output in the first half of the year will be recouped in the third quarter.

However, it cautioned, this early rebound “is expected to give way to a recuperation phase during which the pace of the recovery will moderate, as the pandemic continues to affect confidence and the economy undergoes widespread adjustments, including in the energy sector,” it said.

“As a result, Canada’s economic output will likely take some time to return to its pre-COVID-19 level. Many workers and businesses can expect to face an extended period of difficulty.”

The bank estimated that the inflation rate – a key measure for the central bank, which relies on an inflation target of 2 per cent to guide its interest-rate policy – fell to -0.1 per cent in the second quarter. The bank forecast that even as the economy recovers, inflation would be a thin 0.4 per cent in the third quarter, and just 0.6 per cent for the year as a whole, before picking up modestly to 1.2 per cent in 2021.

Normally, the bank updates its forecasts every quarter in the MPR, but it opted against issuing specific projections in the April report, which came out at the height of the crisis, citing deep uncertainties. Then-governor of the bank, Stephen Poloz, whose term expired in early June, said at the time that providing specific forecasts would provide “false precision” for a highly unpredictable situation.

Tiff Macklem, who took over from Mr. Poloz six weeks ago, will hold a news conference Wednesday to discuss the report and its economic outlook. In his short time on the job, Mr. Macklem has generally struck a more cautious tone than Mr. Poloz, who had been relatively optimistic about the potential for a strong post-COVID recovery.

The bank referred to its new outlook as a “central scenario,” rather than a projection, emphasizing its continued heightened uncertainty surrounding the numbers. The central scenario assumes that there is no widespread second wave of COVID-19, either within Canada or globally, and assumes that the pandemic will have run its course by mid-2022.

Under this scenario, the bank sees the Canadian and world economies rebounding on the second half of 2020 as virus containment measures ease. However, it assumes that continued physical distancing and uncertainty will “continue to restrain economic activity” through 2022.

“Uncertainty around this scenario is considerable,” the bank said. “There are a multitude of scenarios both stronger and weaker than the central one presented here. Yet overall, the risks appear to be tilted to the downside, largely because of the potential for a second wave of the virus.”

Official consumer price index data released by Statistics Canada showed that the year-over-year inflation slumped to -0.2 per cent in April and -0.4 per cent in May, as prices plunged for some products, such as gasoline and travel services, amid a dearth of demand at the height of the economic shutdown. But the Bank of Canada believed the data overstated true consumer prices, as the lockdowns had resulted in dramatic shifts in buying patterns. It noted that a new joint analysis from Statscan and the Bank of Canada released earlier this week, which produced an “adjusted” price index to account for these consumer shifts, put the inflation rate near zero for both months.

“Statistics Canada and the bank will continue to update this new index to calculate an adjusted CPI inflation measure through the recovery period. The difference between the two measures of inflation may dissipate if the changes in consumption patterns reverse,” it said.

Nevertheless, the bank expects inflation pressures to be highly muted for a long time, amid weakened demand. It said that at least so far, there is only “limited evidence” of firms raising prices to reflect increased costs of doing business under the pandemic.

“The path for CPI inflation over the next year largely reflects the influence of energy prices. The dramatic decline in these prices in March and April will hold inflation down until early 2021. After that, the inflation outlook depends primarily on the speed and strength at which demand and supply recover,” the bank said. “Firms report that capacity could return quickly as the economy reopens and containment measures are lifted. They expect the recovery in demand to be more muted, especially in the services and energy sectors.”

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Written by Colin Henderson

July 15, 2020 at 11:08

Posted in Uncategorized

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