MNI STATE OF PLAY: BOC Sees Stronger Inflation, Continues QE

The Bank of Canada said Wednesday inflation will peak around the top of its target band in the next few months and stuck to language about adjusting QE as policy makers gain confidence in a stronger recovery, potentially setting up a taper at the next meeting in April.

Output will likely expand in the first quarter because the economy has been "more resilient than anticipated" to the second wave of Covid-19, policy makers led by Governor Tiff Macklem said after their March meeting, reversing an earlier estimate that GDP will contract at a 2.5% annualized pace.

Consumer price gains are now seen accelerating to around 3% in the next few months compared with the January decision that saw price gains reaching around 2% in the first half of the year. The BOC still says those gains are driven by temporary base effects such as last year's plunge in gasoline prices and will later fade away.

Policy makers left their main guidance on interest rates and asset purchases unchanged, in line with an MNI interview with Macklem last month saying QE would be guided by the inflation target in an economy with a lot of slack. Some investors surveyed by MNI see the pace of asset purchases falling to CAD3 billion from at least CAD4 billion a week now at the April meeting when the BOC can add more evidence of vaccine rollouts into its quarterly economic forecast report.

ECONOMY IS ADAPTING

The BOC reiterated QE will continue until the economic rebound is "well underway." There's some evidence of that now, with a first-quarter expansion following fourth quarter growth of 10% that was also better than expected. But slack in the economy means conditions for raising the 0.25% policy rate likely won't be in place until 2023, the BOC's statement said, while adding in several notes of near-term optimism.

"Consumers and businesses are adapting to containment measures, and housing market activity has been much stronger than expected. Improving foreign demand and higher commodity prices have also brightened the prospects for exports and business investment," the BOC statement said.

The BOC also downplayed the recent jump in bond yields, saying global conditions remain highly accommodative. Canada's 10-year government bond yielded 1.43% Wednesday, below the central bank's 2% inflation target.

"The short statement seems to have taken a 'do no harm' approach, kicking the can down the road until April to make any changes to the conditional commitment or pace of bond purchases," CIBC senior economist Royce Mendes wrote in a research note.

Another consideration for April is whether the government presents a budget that would show the expected supply of bonds needed to finance record deficits, and how much fiscal stimulus will be coming this year. Some investors say the BOC must taper before year-end or it will end up owning half the federal bond market, creating trading frictions.