More fiscal stimulus better than negative interest rates: Ed Devlin
The Bank of Canada will probably brush off the economy’s stronger-than-expected rebound and stick to its narrative of a long and bumpy recovery that will require extraordinary support for years to come.
Governor Tiff Macklem pledged in July to keep the central bank’s policy interest rate at 0.25 per cent for at least two more years, and he’ll almost certainly reiterate that commitment on Wednesday. That’s along with a promise to purchase at least $5 billion (US$3.8 billion) a week in Canadian government bonds to keep borrowing costs low across the yield curve, and to provide even more stimulus if needed.
The measures are part of the central bank’s whatever-it-takes approach to help Canada emerge from the deepest downturn since the Great Depression. Policy makers aren’t likely to stray from that stance even amid signs the economy has snapped back more quickly than anticipated.
Pledging to keep the policy rate unchanged is “a pretty powerful commitment that they’re likely to reiterate,” Josh Nye, economist at Royal Bank of Canada, said by phone.
Second-quarter output plunged 13 per cent from where it was at the end of 2019 -- a historic collapse, but not quite as bad as the Bank of Canada predicted in its latest monetary policy report.
Gross domestic product data for June and July also suggest the recovery has been stronger than the central bank anticipated, potentially putting the economy on track to eliminate spare capacity well before the two-year time frame Macklem outlined.
The federal government’s decision to keep the fiscal taps open into the recovery period -- keeping disposable income elevated -- is also stoking optimism.
Yet, the central bank will attempt to pare expectations Wednesday by underscoring its view that the recovery will slow as the economy enters a bumpy and prolonged “recuperation phase.”
The central bank has committed to a rate freeze until excess capacity is absorbed -- putting it on hold until at least 2023, based on their own forecasts. But Macklem has indicated the central bank could tinker with its asset purchase program before then.
The central bank has said it will do undertake quantitative easing until the recovery is “well underway,” which opens the door for a tapering before it lifts its rate guidance.
Growth in the central bank’s balance sheet has already stalled at about $540 billion since mid July, or about 27 per cent of nominal GDP, as increased holdings of government bonds are offset by declining treasury bills.
That could mean Macklem expects his forward guidance on rates will do much of the monetary policy heavy lifting, and reliance on balance sheet expansion will wane. There’s already concern the central bank’s bond purchases of $5 billion a week are too aggressive, potentially distorting the market.
One way to potentially ease off hard bond purchase guidance without spooking markets could be to introduce yield curve control, where the central bank targets a specific medium-term interest rate. That would allow it to purchase just enough bonds to keep rates on hold, without committing to a specific amount.
But most economists aren’t expecting any major changes to policy until later this year at the earliest, when policy makers will have more clarity on how the pandemic is spreading.
“There’s no need to do that at this point, because interest rates are still very low across the curve,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said by email.
Wednesday’s rate decision won’t include a new set of forecasts, which will come in October. Macklem is scheduled to give a speech and press conference on Thursday.