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MNI STATE OF PLAY: BOC May Keep Rate Guidance, Reinvest QE

MNI (Ottawa)

Governor Macklem has recently shunned inflation hawks to say the economy needs continued support.

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The Bank of Canada on Wednesday will likely stand firm on guidance that conditions for raising the record low policy interest rate will remain out of reach until the second half of next year, while offering inflation hawks another taper of quantitative easing to end new net purchases.

The target overnight lending rate will remain 0.25% in the 10am EST decision according to all 19 forecasts in an MNI survey. Most investors say Governor Tiff Macklem will scale back the CAD2 billion a week of federal bond purchases to either CAD1 billion a week or CAD4 billion-CAD5 billion a month to roughly match maturing assets and keep the balance sheet stable around CAD500 billion. About a third of the market predicts a formal announcement that the "reinvestment phase" has begun.

The BOC must balance inflation exceeding its 1%-3% target band for six months against GDP that unexpectedly shrank in the second quarter. Giving in to inflation hawks would undo several assurances from Macklem that price gains following the Covid reopening won't last and potentially set a bad precedent for its actions versus its forward guidance on rates.


The BOC's revised economic forecasts will be crucial to where rates are headed, given Macklem has said the desired conditions for a rate increase in the second half next year are an economy at full output and inflation sustainably at its 2% target. Including the markdown to reflect GDP that shrank at a 1.1% annualized pace in Q2 and Q3 growth that was likely half the BOC's projection of 7.3% could alter estimates of when the economy hits full potential, even with employment returning to its pre-Covid level in the latest data.

The BOC will also likely boost inflation forecasts again after its July Monetary Policy Report increased the 2021 view to 3% from 2.3%. The CPI rose 4.4% last month, and there should be focus on the 2022 prediction for inflation of 2.4%, which is due for an upgrade.

Choppy GDP data and the difficulty of reading the re-opening has raised investor focus on the BOC's July estimate that the output gap was 2%-3% of GDP. The idea policy makers would tear up its forward guidance on rates because of an overhaul of that forecast is a stretch given the BOC admitted in July that estimates of the output gap were "particularly uncertain."

Macklem may also see a need to keep up monetary stimulus with the fiscal thrust slowing-- the government last week scaled back relief checks to less than CAD10 billion through May from a cost to date of almost CAD300 billion. At the same time, consumers are still flush with cash from the earlier checks that backstop the BOC's optimism around a second-half growth rebound.


Macklem has staked a lot of his own credibility on the need for extended stimulus in a choppy recovery, pointing to slack in the labor market, the need for rate guidance, and saying at his last two public events that inflation pressures are narrow and short lived.

The BOC has almost never moved to raise rates when the latest quarterly GDP data is negative, and often points to flexibility in overlooking short-run bursts in returning inflation to target when trading off against other major risks.

"The BoC still has the latitude to watch how these dynamics play out, especially now that markets are taking matters into their own hands," Jimmy Jean at Desjardins wrote, noting five-year government bond yields have climbed 47bps since early September and could gain another 30bps by the time the BOC lifts rates.