Loonie Surges After Hawkish Bank Of Canada Sees Faster Recovery, Warns Of Upside Inflation Risk

As expected, the Bank of Canada today held its target for the overnight rate at the effective lower bound of ¼ percent, with the Bank Rate at ½ percent and the deposit rate at ¼ percent. The Bank also kept its guidance and QE program unchanged at its current pace of at least $4 billion per week.

In the broadly hawkish statement, the BOC said that while policy settings were unchanged (rates, guidance, QE unchanged), the Bank upgraded its growth view for this year, and for Q4 2020, while seeing inflation as a little firmer this year than it foresaw in October. It also sees the output gap closing earlier than it did when it made forecasts in October.

Below are the highlights from the statement (via Newsquawk):

  • Rates: Unchanged at 0.25% (exp. 0.25%; there was a small risk of a so-called “micro cut”)
  • Guidance: Unchanged “The Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In our projection, this does not happen until into 2023” (prev. rates unchanged until economic slack is absorbed, inflation at target, likely will not happen until into 2023)
  • QE: Unchanged at CAD 4bln/week (prev. CAD 4bln/week)
  • Outlook:
    • Q4 2020 growth view: (prev. -4.3%)
    • Q1 2021 growth view:
    • End-2021 growth view: (prev. 3.8%)
    • End-2021 inflation view: (prev. 1.3%)
  • Output gap view: -2.75% to -3.75% (prev. -3% to -4%, seen closing significantly after 2022)
  • Neutral rate view: Unchanged 1.75-2.75% (prev. seen between 1.75-2.75% in Q3)

Other notable highlights from the Monetary Policy Report: the BOC cut its near term growth estimates on regional lockdowns but raises longer-term outlook on vaccines. It now expects Q1 2021 GDP to contract 2.5% q/q, and revised its 2021 GDP growth down to +4% y/y from +4.2% y/y previous; this however was offset by an upward revision to 2022 GDP growth from 3.7% to 4.8% y/y.

The reason for the optimism: “The Bank assumes that broad immunity is obtained through vaccination by the end of 2021”

The central bank also hiked its 2021 inflation forecast to 1.6% from 1.0%, predicting that “inflation will return “sustainably” to 2% target in 2023 in base-case” and warned of upside risks to inflation outlook: Stronger than anticipated household spending, additional fiscal stimulus from new U.S. administration

The BOC was cautious on the Loonie saying that “further appreciation of the Canadian dollar could slow output growth by reducing the competitiveness of Canadian exports and import-competing production” although it noted that its “projection still depends importantly on how the pandemic and vaccination efforts evolve. “

In an updated to its QE program, the BOC said any decrease in balance sheet due to runoff of short-term securities won’t necessarily indicate a reduction of stimulus, and added that maturing term repos means Bank of Canada balance sheet will likely decrease but that doesn’t mean stimulus will be less: “The degree of exceptional monetary stimulus is linked to QE operations.”

“The stock of purchases provides an indication of the total amount of exceptional stimulus. In the coming months, the Bank’s holdings of GoC bonds will continue to increase, further supporting the recovery.”

It also noted that since recalibration of the program in October, weighted average maturity of QE purchases since October is more than 7 years. The average maturity had been around 6 years between July and October and about 5 years between April and July.

The BOC noted that total balance sheet has 18% of assets maturing in 10 years or more, versus 15% in Oct. In terms of composition, Government of Canada bonds make up 55% of assets, raising bank ownership of bonds outstanding to 36%.

As a result of the broadly hawkish undertone (where the warning of higher inflation was the primary theme), the loonie surged in kneejerk response, perhaps catalyzed by some whisper expectations of a micro rate cut by the BOC, which clearly isn’t happening.