March 11, 2021
In economic forecasting, two years can seem like an eternity.
But that’s how long the Bank of Canada expects to wait before raising interest rates. Economists and other rate-watchers, however, believe the central bank could be forced to make a move long before then, thanks to a quicker-than-expected recovery from the COVID-19 pandemic.
“I don’t know whether they’re going to be able to keep rates here for a full two years,” said James Laird, president of online rate-monitoring site Ratehub.ca after the Bank of Canada announced Wednesday it was maintaining its key overnight lending rate at 0.25 per cent.
The central bank also said it wouldn’t be raising the rate until inflation consistently stays around two per cent, something it doesn’t believe will happen until some time in 2023. And it said it would be continuing its policy of quantitative easing, adding up to $4 billion a week to the economy. Raising interest rates is the central bank’s key tool in fighting inflation.
Mortgage rates have already started to edge up in tandem with yields on five-year bonds, as markets start to take note of several positive economic signals, including growth in fourth quarter gross domestic product, Laird pointed out. In ordinary times, those bond yields would typically also be a signal that the Bank of Canada could be ready to start raising rates. But that hasn’t happened so far.
“There’s a bit of a disconnect between what the Bank of Canada is saying and what the bond markets are pricing in,” Laird said.
The size of the national economy grew 2.3 per cent in the fourth quarter, Statistics Canada reported last week. Prices of commodities produced in Canada — in particular oil — have also been rising lately on soaring global demand.
Still, the growth in the economy is tempered by the reality that there are still far more Canadians out of work than before the COVID-19 pandemic struck, and that certain economic sectors could be looking at years before they fully recover, said Benjamin Reitzes, an economist with BMO Capital Markets.
“We’ve had some very strong data showing growth, but unemployment is still at nine per cent. We’re not fully recovered yet,” said Reitzes, BMO’s Canadian rates and macroeconomics strategist.
While Reitzes admits he’s more bullish than some other economists on Canada’s prospects for recovering from COVID, BMO’s official forecast still doesn’t have the Bank of Canada raising rates until July 2023.
Nor does National Bank Financial.
“The (central) bank’s projections ... look increasingly outdated and are in need of some upward revisions. But while the nature of forward guidance may have to change, we currently don’t see a rate hike coming before 2023,” National Bank’s economics team said in a note to clients.
The vastly-disparate effects of the COVID recession on different sectors of the Canadian economy make the blunt instrument of raising or lowering interest rates even trickier than usual to get right, Reitzes said. Statistic after statistic has shown that sectors including hotels, restaurants and airlines have seen greater revenue drops and job losses than other sectors, while some sectors are already starting to bounce back, Reitzes said.
“There’s no question that makes it more difficult to get right. But this is a balancing act the Bank of Canada has been doing for over a decade,” said Reitzes.
In particular, Reitzes pointed to the recession following the financial crisis of 2008, when the Ontario and Quebec economies were struggling greatly, and could have used a boost from lower interest rates. At the same time, Alberta’s oil-fuelled economy was booming, raising the risk of heavy inflation if interest rates had fallen.
The persistently-high unemployment rate also makes it less likely that economic growth would trigger high inflation, argued a report from TD Bank.
“Even while some areas of the economy are outperforming, others are struggling. Over 500,000 workers have been unemployed for 27 weeks or more, and until these Canadians find new opportunities, inflationary pressures are likely to be modest,” said the TD report.
There could, in fact, be even more bad news on the employment front, despite broader economic gains, suggested Arlene Kish, chief Canadian economist at consultancy IHS Markit.
“Women, youths, and low-wage workers have been most negatively affected by the pandemic through job losses. The threat of a third wave will only exacerbate the challenges for these employment demographics, providing greater odds of permanent job losses during the recovery period,” Kish wrote in a research note.