Bank of Canada signals rate hike in 2022, tapers bond purchases

Julie Gordon and David Ljunggren
·3 min read
FILE PHOTO: Governor of the Bank of Canada Tiff Macklem walks outside the Bank of Canada building in Ottawa

By Julie Gordon and David Ljunggren

OTTAWA (Reuters) -The Bank of Canada signaled on Wednesday that it could start hiking interest rates in late 2022, as it sharply boosted its outlook for the Canadian economy and reduced the scope of its bond buying program.

The central bank said it now expects economic slack to be absorbed in the second half of 2022, from a previous forecast of into 2023. It held its key overnight rate steady at 0.25%.

Governor Tiff Macklem, speaking to reporters after the decision, made clear that while the bank is committed to refrain from raising rates until the economy is running at full capacity, there is no guarantee borrowing costs will rise when those conditions are met.

"What we do when those conditions are met, we'll have to assess that at the time. There's nothing mechanical," he said, adding: "We're looking for a full recovery, we're not going to count our chickens before they're hatched."

The Bank also said it now believes the COVID-19 pandemic will be "less detrimental" than previously assessed to the economy's potential output.

Canada's annual inflation rate doubled to 2.2% in March, Statistics Canada said separately, in part due to a statistical effect caused by a sharp deceleration last year during the coronavirus pandemic.

The Bank of Canada targets the midpoint of an control range of 1% to 3%. It expects inflation to temporarily rise to about 3% this year, before falling to around 2% in the second half. It will then fall further in early 2022 before recovering.

Canada's economy is expected to grow 6.5% in 2021, up from a forecast of 4.0% in January, the central bank said in its spring Monetary Policy Report, also released Wednesday.

It sees economic growth in the United States, which is Canada's largest trading partner, at 7.0% this year, up from 5.0%.

Much of the growth comes down to a massive U.S. stimulus plan passed in March and Canada's own stimulus package, unveiled Monday as part of Prime Minister Justin Trudeau's government's first budget in more than two years.

"Our projection at a macro level really captures the fiscal stimulus that has been announced both by provincial governments and to a large degree the federal government," said Macklem.

BOND TAPERING

The Bank of Canada cut its weekly net purchases of Canadian government bonds to a target of C$3 billion ($2.4 billion) from C$4 billion, saying the adjustment reflected the progress made in the economic recovery.

"Certainly this is a more hawkish statement that begins to lay the foundations for the removal of the substantial monetary policy support that has been put in place over the past year," said Josh Nye, senior economist at RBC Economics.

While recent job growth looks positive, the Bank warned it may take considerable time for full employment to be reached. Due to population growth, Canada needs to add 475,000 jobs to return to its pre-pandemic employment rate, it said.

The Canadian dollar strengthened as much as 1.2% to 1.2459 per greenback, or 80.26 U.S. cents, its biggest gain since last June, while Canada's 2-year yield jumped about 4 basis points to 0.334%.

(Reporting by Julie Gordon and David Ljunggren, additional reporting by Steve Scherer, Fergal Smith, Nia Williams, Jeff Lewis and Moira Warburton; Editing by Franklin Paul, Paul Simao and David Gregorio)