The Bank of Canada keeps its key policy rate unchanged, but revises its 2021 inflation forecast higher thanks to the economy reopening and supply chain disruptions. Anthony Okolie speaks with James Orlando, Senior Economist, TD Bank, about the outlook for Canada’s economic recovery.
Print Transcript
[MUSIC PLAYING]
- The Bank of Canada kept its overnight rate steady at 25 basis points, but still sees rates on hold until sometime in 2022. James, what stood out for you today?
- Yeah, thanks, Anthony. Today's announcement really was a reinforcement of the narrative that the economic recovery is moving in the direction that the Bank of Canada thought it was going to go. We know that the Canadian economy is reopening after some serious restrictions in the spring. You're really seeing it in the economic data right now, and we're seeing it just anecdotally.
Walking around town, you're seeing that restaurants' reservations are getting filled up, bars are packed. So this rebound in economic momentum that the Bank of Canada was expecting is coming to fruition. So I think the Bank of Canada's report today is really just a reinforcement of that narrative.
ANTHONY OKOLIE: And just to touch on that point, we also saw that they're again tapering the weekly bond purchases. What does that suggest to you?
- Yeah, so remember that the weekly bond purchases, this is quantitative easing, effectively, right? So what they're doing is they're going out and they're buying Canadian bonds in the open market in an effort to keep government yields low. This is supposed to stimulate the economy. It's supposed to feed through to things like corporate bonds and mortgage rates, keep all of those rates low. And the Bank of Canada has communicated that this is necessary to help the recovery move along as fast as it possibly can.
So as the recovery does move along and things are moving the way Bank of Canada kind of expects, the need for continued asset purchases is lower and lower. And you're also in a situation where the government of Canada, as the economy reopens, is going to issue less and less debt. And so the need for the Bank of Canada to step in to support markets is obviously lessened. And so the asset purchase reduction doesn't come as a surprise, and it really isn't needed. The need to keep yields low when things are booming is much less.
ANTHONY OKOLIE: Now, the Bank of Canada also raised their inflation targets, but they do see it as temporary, sort of echoing what the Fed has been saying. What are your thoughts there?
- Yeah, so we know that a lot of the inflation we're seeing right now is really just a reflection of where we are today versus where we were a year ago, in the midst of the worst part of the pandemic. Things like oil prices that were negative at one point in time last year have rebounded to decent levels. And so inflation is the rate of change of prices, right? So as these temporary factors sort of wash out of the data, the Bank of Canada is saying that things will go back to more normal levels.
The other thing is that the pandemic has caused a huge change in how we spend our money. The fact that services were so restricted, it caused a flood into purchases of goods. And you saw semiconductor shortages, prices of used cars increasing because people, obviously, didn't want to take public transit during the midst of a pandemic. So these dislocation in prices really should be temporary.
The issue is that we're starting to see wage growth accelerating. We're starting to see even anecdotal information about companies giving perks to people just for interviewing, or a sign-on bonus in a wide array of income spectrum jobs. And so the risk is that prices will stay elevated for longer than even the Bank of Canada is expecting. So it's definitely something to watch out for. You know the Bank of Canada is monitoring this very closely.
- And I want to follow up on that. When you talk about risks, what do you see as the banks-- what are the risks to the banks' outlook over the near term?
- Yeah, so inflation is definitely a risk. The expectation that we're going from really hot inflation right now back to more normal levels, like, that's all well and good in theory, but you've got to see it actually happen. We know that prices can stay dislocated for longer than people expect, and that can cause problems in things like asset markets, as well.
And the other thing that, obviously, the Bank of Canada is worried about is anything that's going to slow down this economic recovery. We hear a lot about delta variants or mutations of the virus. If this causes a fourth wave, if it causes more social restrictions in the fall period, that would dent economic growth. It would slow down our recovery, and it would delay the amount of time it takes for us to completely heal from this pandemic.
Things are looking great right now. The vaccination rates are doing really well, and they're clearly working. You don't want a slowdown in this economic momentum. But that really is the main risk that I think the Bank of Canada and we're worried about, too.
- And finally, just after the report came out, we did see a bit of weakness in the Canadian dollar. Where do you see the loonie going in the next little while?
- Yeah, so the loonie right now is trading at around what we call a fair value. So that's the value that it should trade at when everything is kind of balanced in the economy versus what's happening in the US. We'd argue that, for the Canadian dollar to trade higher than current levels, you're going to need two things to happen. One is the Canadian economy is going to have to really outperform the US economy. And that would be usually based on the fact that either our exports are doing well, things like oil prices are increasing substantially.
And this would then cause the Bank of Canada to have to raise interest rates well ahead of what the Federal Reserve is doing. That's not our call right now, but those are the things that I think investors should watch out for for the Canadian dollar to trade higher than where we are right now. But we're at a pretty comfortable level, based on our numbers.
- James, thanks again for your insights.
- Thank you.
[MUSIC PLAYING]
- The Bank of Canada kept its overnight rate steady at 25 basis points, but still sees rates on hold until sometime in 2022. James, what stood out for you today?
- Yeah, thanks, Anthony. Today's announcement really was a reinforcement of the narrative that the economic recovery is moving in the direction that the Bank of Canada thought it was going to go. We know that the Canadian economy is reopening after some serious restrictions in the spring. You're really seeing it in the economic data right now, and we're seeing it just anecdotally.
Walking around town, you're seeing that restaurants' reservations are getting filled up, bars are packed. So this rebound in economic momentum that the Bank of Canada was expecting is coming to fruition. So I think the Bank of Canada's report today is really just a reinforcement of that narrative.
ANTHONY OKOLIE: And just to touch on that point, we also saw that they're again tapering the weekly bond purchases. What does that suggest to you?
- Yeah, so remember that the weekly bond purchases, this is quantitative easing, effectively, right? So what they're doing is they're going out and they're buying Canadian bonds in the open market in an effort to keep government yields low. This is supposed to stimulate the economy. It's supposed to feed through to things like corporate bonds and mortgage rates, keep all of those rates low. And the Bank of Canada has communicated that this is necessary to help the recovery move along as fast as it possibly can.
So as the recovery does move along and things are moving the way Bank of Canada kind of expects, the need for continued asset purchases is lower and lower. And you're also in a situation where the government of Canada, as the economy reopens, is going to issue less and less debt. And so the need for the Bank of Canada to step in to support markets is obviously lessened. And so the asset purchase reduction doesn't come as a surprise, and it really isn't needed. The need to keep yields low when things are booming is much less.
ANTHONY OKOLIE: Now, the Bank of Canada also raised their inflation targets, but they do see it as temporary, sort of echoing what the Fed has been saying. What are your thoughts there?
- Yeah, so we know that a lot of the inflation we're seeing right now is really just a reflection of where we are today versus where we were a year ago, in the midst of the worst part of the pandemic. Things like oil prices that were negative at one point in time last year have rebounded to decent levels. And so inflation is the rate of change of prices, right? So as these temporary factors sort of wash out of the data, the Bank of Canada is saying that things will go back to more normal levels.
The other thing is that the pandemic has caused a huge change in how we spend our money. The fact that services were so restricted, it caused a flood into purchases of goods. And you saw semiconductor shortages, prices of used cars increasing because people, obviously, didn't want to take public transit during the midst of a pandemic. So these dislocation in prices really should be temporary.
The issue is that we're starting to see wage growth accelerating. We're starting to see even anecdotal information about companies giving perks to people just for interviewing, or a sign-on bonus in a wide array of income spectrum jobs. And so the risk is that prices will stay elevated for longer than even the Bank of Canada is expecting. So it's definitely something to watch out for. You know the Bank of Canada is monitoring this very closely.
- And I want to follow up on that. When you talk about risks, what do you see as the banks-- what are the risks to the banks' outlook over the near term?
- Yeah, so inflation is definitely a risk. The expectation that we're going from really hot inflation right now back to more normal levels, like, that's all well and good in theory, but you've got to see it actually happen. We know that prices can stay dislocated for longer than people expect, and that can cause problems in things like asset markets, as well.
And the other thing that, obviously, the Bank of Canada is worried about is anything that's going to slow down this economic recovery. We hear a lot about delta variants or mutations of the virus. If this causes a fourth wave, if it causes more social restrictions in the fall period, that would dent economic growth. It would slow down our recovery, and it would delay the amount of time it takes for us to completely heal from this pandemic.
Things are looking great right now. The vaccination rates are doing really well, and they're clearly working. You don't want a slowdown in this economic momentum. But that really is the main risk that I think the Bank of Canada and we're worried about, too.
- And finally, just after the report came out, we did see a bit of weakness in the Canadian dollar. Where do you see the loonie going in the next little while?
- Yeah, so the loonie right now is trading at around what we call a fair value. So that's the value that it should trade at when everything is kind of balanced in the economy versus what's happening in the US. We'd argue that, for the Canadian dollar to trade higher than current levels, you're going to need two things to happen. One is the Canadian economy is going to have to really outperform the US economy. And that would be usually based on the fact that either our exports are doing well, things like oil prices are increasing substantially.
And this would then cause the Bank of Canada to have to raise interest rates well ahead of what the Federal Reserve is doing. That's not our call right now, but those are the things that I think investors should watch out for for the Canadian dollar to trade higher than where we are right now. But we're at a pretty comfortable level, based on our numbers.
- James, thanks again for your insights.
- Thank you.
[MUSIC PLAYING]