Despite being similarly positioned for economic recovery, the two central banks may adopt different timelines
With vaccinations and business reopenings in full swing in both the U.S. and Canada, the two countries are squarely on the path toward an economic rebound from the crisis precipitated by the pandemic. But their respective central banks will likely have different timelines towards normalizing their monetary policies.
In a blog post dated June 4, David Stonehouse, senior vice-president and head of North American and Specialty Investments at AGF Investments, noted how the Bank of Canada struck a buoyant tone in its April Monetary Policy Report, increasing its GDP growth estimate for 2021 by 250 basis points to 6.5%. It also pulled forward some growth from 2022 (estimated GDP at 3.7%, a 110-basis point revision downward) and raised its 2023 estimate (3.2%, a 70-basis point increase).
“The bank’s revised inflation expectations are even more illustrative,” Stonehouse said. The BoC’s expected CPI inflation to hit 2.3% in 2021, 1.9% for 2022, and 2.3% for 2023. “In short, the bank is telling markets that it expects more growth and more inflation – averaging 2%-plus over the next three years – than it did just three months ago.”
Beyond that, he pointed to the BoC’s extreme aggressiveness in its quantitative easing program last spring. If it had maintained its initial pace of purchasing $5 billion in bonds a week, it would have ended up owning 60% of Canadian government bonds by the end of this year. But the central bank started paring back its QE purchases in the fall, and by April had dialled it down to $3 billion weekly – a relative standstill rate considering the average weekly net issuance of roughly $3.5 billion for the fiscal year 2021-22, as per the government’s current budget.
Because the BoC has not abandoned its monetary policy mandate of maintaining inflation at or around 2%, and given concerns over its level of intervention in the bond market, the central bank appears poised for a more hawkish response. Market expectations, Stonehouse said, called for a rate hike within the second half of 2022, six months earlier than previous projections.
In contrast, he pointed to the Federal Reserve’s less focused mandate of average inflation targeting, which ostensibly gives it the discretion to let the U.S. economy run above its historical 2% inflation target for a certain period if sustained full employment, which is somewhere around a 4% unemployment rate, has not yet been achieved. With that, he said the market expects the Fed to begin tapering in late 2022 or the first half of 2023.
“[T]he Fed may not talk about tapering until later this year and could wait until either side of year end to begin the process,” Stonehouse said.
Since the blog post was published, both Canada and the U.S. have seen run-ups in inflation.
Canadian annual inflation in April registered at 3.4%, though BoC Deputy Governor Tim Lane said in a post-policy rate decision speech that the central bank expects inflation to remain around 3% over the next several months before it starts on the path to moderation. Aside from the transitory base-year effects naturally arising from unfavourable comparisons to last year, he said that “underlying slack” will persist to keep inflation in check as the base-year effects subside. Still, following the BoC’s June 9 decision to stand pat on its key interest rate, analysts widely expected it would announce its next taper during its July 14 decision.
Meanwhile, the U.S. Labor Department revealed last Thursday that the country’s CPI in May surged by 5% on an annual basis, reportedly the fastest acceleration since the 5.4% logged in August 2008. Aside from base-year effects, the increase in May could be linked to price increases driven by costs of flights, household furnishings, new cars, rental cars, and apparel.
That has tilted the scales slightly toward an earlier-than-expected Fed tapering, though analysts and economists still project the central bank will not dial down its bond purchases until next year.
