MNI STATE OF PLAY: BOC Stuck With GDP Setback and Hot Prices

The Bank of Canada's policy decision Wednesday should acknowledge the economy has lost a step after earlier resilience to Covid disruptions, even as well-above-target inflation sustains pressure on for halting net bond purchases as soon as October.

While markets were shocked by Aug. 31 reports output fell in the second quarter and again in July even after a large majority of Canadians were vaccinated against Covid, the BOC also knows inflation could outpace the top of its 1% to 3% target range for the rest of the year.

Investors surveyed by MNI universally predict the BOC will hold QE at a CAD2 billion weekly pace and keep the key overnight lending rate at 0.25% in a decision due at 10am EST on Sept. 8.

Sources told MNI even before the slowdown that October was likely the earliest possible date for a fourth round of tapering to CAD1 billion -- a pace at which net purchases are likely about zero when measured against maturing assets. The GDP miss could push back the timing of a taper a little, but the BOC doesn't need to signal a delay at this meeting because there's no new economic forecast to back it up.

UNDERLYING CONSUMER MOMENTUM

While campaigning before the Sept. 20 election keeps Governor Tiff Macklem from sounding too pessimistic, the outlook itself was already quite strong. The Bank in July saw Q3 growth at a solid 7.3% annualized pace on consumer spending so even a markdown leaves room for a good expansion. Part of the Q2 decline could also be one-off factors such as auto exports disrupted by a global chip shortage, and what's likely a healthy slowdown in hyperextended demand for housing and lumber.

Much of the BOC's optimism for the second half is also based on consumers still flush with cash. Massive government stimulus checks will flow through at least October, payments so large a national savings rate that was negligible before the pandemic is now in double digits.

Tapering bond purchases also helps QE from becoming a self-defeating policy that frays market trading, with the BOC's holdings still approaching 50% of the stock. Macklem has said QE's primary benefit is to help reach his 2% inflation goal, and continuing those purchases would also further add to one of the biggest tests of the Bank's inflation target in decades.

The BOC on July 14 scaled back weekly bond purchases to CAD2 billion from CAD3 billion on more signs of a solid economic rebound and affirmed guidance for raising the record low 0.25% policy interest rate in the second half of next year, keeping it more hawkish than the Fed and ECB. The 1.1% annualized decline in Q2 GDP isn't yet enough to write off that outlook, analysts said.

NEW DEPUTY ON BOARD

Inflation pressure is more obvious. Headline CPI gained 3.7% in July for the biggest rise in a decade, in the fourth month above Macklem's target band. The average of the three core CPI measures tracked by the Bank of Canada was 2.5%, the fastest since 2009, straining the BOC's July rate affirmation price gains are transitory.

Any potential shift on QE will likely come in this key line from the July decision: "Decisions regarding further adjustments to the pace of net bond purchases will be guided by Governing Council's ongoing assessment of the strength and durability of the recovery."

This is also the first rate meeting with Sharon Kozicki as a deputy, a longtime insider the market expects would back the status quo outlook. Senior Deputy Governor Carolyn Rogers doesn't arrive until December from the BIS.