The Bank of Canada kept its key policy rate unchanged, noting the medium and long-term outlook for the Canadian economy had improved due to vaccine approvals and increased fiscal stimulus. Anthony Okolie speaks with James Orlando, Senior Economist, TD Bank, about the impact of this lower for longer interest rate policy.
- The Bank of Canada kept its overnight rate unchanged at 25 basis points and re-pledged to keep rates on hold until 2023. James, what's the long-term impact of this lower for longer policy?
- Yeah, great question, Tony. When we're looking at the policy rate for the Bank of Canada, just committing to saying, we're going to keep rates at the floor until 2023, it's pretty huge because we know the impact of low interest rates. The impact is it incentivizes people to take on greater amounts of debt. And you saw that in Canadian housing with respect to housing demand, people buying new housing, moving to the suburbs, buying bigger houses. And so the incentive to take on debt is going to be in place for a while.
From the investment side of things, we know that investors are looking at low-bond yields. They're looking at the low potential investment returns. And so you're seeing people, when you're seeing low potential interest rates and low returns, what they're doing is they're moving up the risk spectrum. They're taking on more risk. They're increasing their allocation to equities.
- And given the renewed lockdowns that we've seen in this country, as well as a slower rollout of vaccines so far, could we potentially see some micro cuts in the area of 10 to 15 basis points down the road? Do you think that's a possibility?
- Yeah, so you make a good point in the sense that the next little while, the next-- we've seen it already starting in December. We're seeing it in January. Lockdowns are going to hurt economic growth. So the near-term risks are very, very high.
With respect to whether the Bank of Canada needs to do something on this, I don't think they do need to do a micro cut. There's definitely talk about that right now. One thing to consider is that you already have three-month Canada T bill rates very low, well below 25 basis points, which is the Bank of Canada policy rate. So they do risk that if they cut any lower, they could push yields into negative territory.
So there's something to consider with respect to if they think it's warranted or not. There's definitely pressure, a little bit of pressure building, just because you think about Canada being at 25 basis points. The Federal Reserve, their effective rate is 10 basis points.
The Bank of England in the UK, they're at 10 basis points, as well. Same with Australia. So if they're going to do this, they need to communicate it very well because you already see rates very low. And you don't want to be in a situation where the UK, they cut to 10 basis points, and their yields across a lot of the short end of the curve are negative.
- And, of course, today was a historic day. The Biden administration is being sworn in. I want to find out from you, do you see any immediate impacts to the Bank of Canada's policy, at least in the short term?
- It really shouldn't impact the Bank of Canada too much. We know, with respect to President Biden, what he is looking at for his policy agenda, especially over the next few months. He's talked about fiscal policy and just providing that income support to Americans. And that's just really big for the economic narrative.
We saw how just making sure that the government's stepping in to support people that lose their jobs, making sure they support their income is important. And the reason why it's important is because we're looking at this economic rebound in 2021. That's definitely looking like it's being encouraged with the vaccine rollout.
But what's happening is that economic rebound will be even better if people, the citizens of the United States or even Canada, if our incomes are supportive, we're in a better financial situation. If we're in a good financial situation when we're recovering, that economic rebound's going to be that much stronger. So Biden's commitment to fiscal policy is just playing into that even more.
- Where do you see the loonie going in the next little while?
- Yeah, the loonie's done great over the last little bit of time. We're actually fairly close to what we consider fair value on the loonie. And that's a lot to do with the fact that just the US dollar has sold off against most major currencies.
The next leg up, though, for the Canadian dollar, I think, is going to be on energy. We've seen how energy prices have started to rebound over the last few months. They've actually lagged other non-energy commodities. Things like base metals have done well, forestry product, agriculture products. They've done unbelievably well with the economic rebound.
And so our view is that it's energy's turn over the next few months. And energy really is impacted based on things like mobility, us driving cars, flying in planes. And so as the economy recovers, as we start going back to normal, energy prices should be following suit. And that should be able to push the Canadian dollar towards $0.80 and potentially above it.
- Bottom line, what should investors take away from this announcement today?
- Well, I think the big takeaway is the Bank of Canada is committed to keeping policy rates at the floor for the next few years. We've seen how that resulted in lower bond yields in Canada. It's made, really, the incentive for governments to be able to increase fiscal policy there. So just having rates at zero for a long period of time, it's going to support the government to be able to continue to support the economy, continue to support people's incomes. And it just sets us up for a really nice recovery into 2021.
- James, thank you very much for your insights.
- Thank you.