BoC takes the back seat with CAD focused on external factors

27th October 2020 – Bank of Canada Rate Decision Preview

At 1400GMT/1000EDT on Wednesday the 28th of October, the Bank of Canada releases its latest interest rate decision and statement on monetary policy, as well as its latest Monetary Policy Report (MPR) containing updated economic forecasts. The meeting will be followed by a press conference with Governor Macklem and Deputy Governor Wilkins at 1515GMT/1115EDT.

EXPECTATIONS

Most analysts do not expect any major changes to BoC policy at tomorrow’s meeting; rates are seen being held at the bank’s effective lower bound (ELB) of 0.25% and the bank is expected to reiterate that policy will remain highly accommodative “until slack is fully absorbed” in its statement on monetary policy. Despite recent comments from the BoC Governor that NIRP is in the bank’s toolkit, most analysts do not see it as under active consideration. The tone of the statement is expected to be cautious; the bank will note how the North American economic recovery since July has been better than expected (hence the upgrade to the economic forecasts in the MPR) and may praise ongoing fiscal support in Canada. However, they will likely also point to growing risks posed by the worsening global state of the Covid-19 pandemic, sluggish domestic inflation and a lack of fiscal aid south of the border. Asset purchases is where things are somewhat more uncertain; the BoC has unwound a number of its more unconventional emergency liquidity programmes over the last few months, resulting in a contraction in the size of its balance sheet, but its flagship asset purchase programme is seen by most analysts as remaining unchanged at its current rate of CAD 5bln per week.

MPR

Given the data since July, it is clear that July’s Monetary Policy Report was far too pessimistic, as far as growth in 2020 in concerned anyway. Q2 GDP came in almost 2% above the BoC’s forecast and TD Securities are tracking Q3 growth at an annualised rate of 45% (vs the BoC’s July forecast of 31.3%). Thus, the bank’s forecasts for Canadian GDP in 2020 (previously -7.8%) ought to receive a significant upgrade; TD Securities forecast that the drop in GDP in 2020 will be roughly 5.7%. However, this more optimistic take on the economy is unlikely to extend to 2021; with a faster rebound from the March/April hit in 2020 comes the prospect of less “easy progress” ahead. Moreover, the 2021 forecast in July assumed no material second Covid-19 wave in Canada; this has already begun to materialise. TD Securities expect the bank’s 2021 growth forecast to be downgraded by 0.5%-1.0%, consistent with the BoC’s notion that the recovery is likely to slow as it progresses, as well as the downbeat Q3 Business Outlook Survey. In terms of inflation, CPI forecasts are unlikely to see sizeable tweaks (previously 0.6% for 2020 and 1.2% for 2021), and will in any case remain well below the BoC’s 2% inflation target, indicating that lift off is still some way away (2023 in the bank’s base case outlook).

QE, YCC

Following a rush of stimulus back in late Q1/early Q2 as the Covid-19 pandemic sent the much of the world into lockdown, the BoC has been winding its neck back in; the Canada Mortgage Bond (CMB) Purchase Programme will stop at the end of October, the final Bankers’ Acceptance (BA) Purchase Facility operation will be held on October 26th, T-bill purchases have been scaled back from 40% of each issue to 10% and purchases of provincial bonds have dropped to roughly half their pace since late May. “The decision to scale back its credit easing programs reflect a broad improvement in financial conditions,” observes TD Securities, “but we do not think they should be interpreted as a sign that the Bank is looking to tighten policy more broadly”. The investment bank takes the BoC at face value when they say that the Provincial program will continue until its scheduled conclusion next May. Meanwhile, TD Securities thinks there is a risk that the BoC might opt to go down the route of Yield Curve Control (YCC). 30-year bond yields are up 22bps since the July MPR, whilst 10-year yields are up a more modest 13bps, hardly signalling an imminent need to keep government borrowing rates in check. However, TD Securities argue that Governor Macklem “has been proactive through the first three months of his tenure, and if the BoC concludes that YCC will ultimately be necessary in Canada, he may not wait for a sell-off”. TD adds that when the BoC tweaked its forward guidance earlier on in the year to emphasise that it would not be raising rates for a long time, there was not too pressing a need to do so at the time, rather the BoC was just seeking to get ahead: they may apply similar thinking to YCC?

NIRP

As negative rates discussion heats up at the BoE, RBA and RBNZ, investors naturally question whether the BoC might also be tempted by the allure of NIRP. Indeed, earlier in the month BoC Governor Macklem did comment on negative rates, noting that they remain in the toolbox. TD Securities saw this comment “purely as a factual acknowledgement that negative rates are in the toolbox” and, while “it struck some in markets as a change in view… if the BoC was seriously considering a revision to the ELB we have to believe they would’ve done much more to lay the groundwork for the policy shift.” CIBC express similar sentiment; “it’s clear to us that the Bank of Canada, having passed over the opportunity to go below 0.25% when the economy was in even more dire straits in the Spring, believes that lower rates, given the squeeze they put on the workings of the banking system, would not be helpful.” On Macklem’s recent comments regarding NIRP being in the BoC’s toolbox, they comment “when someone says “never say never” about something, as Governor Macklem did in reference to negative rates, the implication is that it’s not under active consideration. Instead, repeated references to 0.25% as the effective lower bound speak volumes about the Bank’s disinclination to view a lower rate as a useful tool.”

CAD

Changes to the MPR will likely drive most of the market reaction to tomorrow’s meeting, thinks ING, though “with the probabilities of further stimulus by the BoC being rather low, we doubt the impact on CAD will be sizeable” they add. Thus, CAD dynamics for the rest of the week will likely be determined by external factors, such as pre-US Presidential election nerves and the continued worsening of the global Covid-19 pandemic. “Any risk aversion driven downside should prove corrective rather than a change in trend” comment Credit Agricole, whose “big picture view” continues to favour CAD strength

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