An optimistic outlook and rising probabilities about a rate hike in 2022 suggest that Canada could lead the policy normalization cycle this time. Positive support for the Canadian dollar and a rally will be witnessed once the domestic virus situation improves. It will be interesting to see if the Federal Reserve would hint at a more upbeat outlook next week.
BoC holds rates, but tapers asset purchases again
Bank of Canada has left the policy rate unchanged at 0.25% in the April meeting but has reduced its weekly asset purchases from 4 to 3 billion Canadian dollars starting from next week. An adjustment that reflects the progress made in the economic recovery as stated in the bank’s policy statement. Back in October, BoC announced its first tapering from 5 billion.
Outlook improves and Resilience is the key
The upbeat press release affirmed that outlook has improved for both domestic and global economies while referring to better than expected resilience in the face of the COVID-19 pandemic. Bank of Canada did also acknowledge that Q1 growth was considerably stronger than the Bank had forecasted back in January, with continuing adaptation to second wave and associated restrictions. Indeed, recent economic activity shows that Canada is on track to full recovery from the economic downturn caused by the pandemic last year. The economy benefits from rising commodity prices and demand as well.
Bank of Canada is now expecting GDP at 6.5% this year, followed by 3.75% growth in 2022 and 3.25% in 2023. Inflation is expected to hit the target of 2% on a sustainable basis in the second half of 2022.
Rate hike is now on the table
The statement signals a sooner rate hike once inflation hits targets, which is now expected during the second half of next year, instead of 2023 as previously expected.
“We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. Based on the Bank’s latest projection, this is now expected to happen sometime in the second half of 2022.”
Inflation heading back to target
Recent data showed annual CPI at 2.2% in March, from 1.1% a year earlier. Common CPI Index rose from 1.3% to 1.5%, while trimmed CPI jumped faster than expected to 2.2%, from 1.9% previously. Inflation readings came in line with BoC’s forecasts in which inflation is expected to rise temporarily over the next few months to the top of the target range between 1-3%. Inflation acceleration is supported by prices recovery after an earlier sharp fall affected by the pandemic. In addition to the latest increase in oil prices since December which led gasoline prices above pre-pandemic levels.
Policy normalization supports a positive CAD outlook
The Canadian dollar rallied after the meeting pushed by hawkish forward guidance and upbeat economic forecasts, while the asset purchasing tapering was widely expected. However, rallies are expected to be capped by the Covid-19 emergency in Canada. On the other hand, oil underperformance may continue which could dampen economic activity. CAD may reverse some of its gains by the end of the week before sustaining its uptrend.
But assuming that current restrictions prove effective in curbing the contagion in Canada, especially after accelerating vaccine pace, and oil prices continued to support the economy and prices, CAD may find a smoother track towards new highs in the medium-term.
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