BoC June Decision – After the Rescue, Time To Support Recovery

The Bank of Canada sees the light at the end of the tunnel. The worst is behind us. Accordingly, future monetary policy actions will be driven with the achievement of the 2% inflation target in mind, contrasting with the urgent interventions that saved Canada from an even worse situation during the March-May period.

The large range of economic scenarios presented on page 18 of the April Monetary Policy Report has narrowed, according to a key passage of the June statement: “the Canadian economy appears to have avoided the most severe scenario.”

Particularly, the expected range of quarter-over-quarter decline in real GDP for 2020 Q2 now stands between 10% to 20%, less than previously anticipated. The BoC basically uses an elimination process based on encouraging information received about the fading pandemic and the reopening of the economy. But since “uncertainty about how the recovery will unfold remains high,” the BoC could not go as far as saying the best-case scenario pictured in the MPR becomes the base-case scenario.

The improving economic and financial environment also diminished the need for the central bank’s assistance relative to market functioning, particularly for short-term assets. BAs held by the BoC soared in April and fell back to normal levels during the month of May as no purchases occurred under the Bankers’ Acceptance Purchase Facility (BAPF) program since late April. Accordingly, the BoC will reduce the frequency of its BAPF from once a week to once every two weeks. After the July 6 BAPF operation, the next one will occur on July 20. In addition, the BoC will cap the frequency of its term repo operations to once per week, effective June 16. Covered bonds, term ABS and ABCP remain eligible for term repo operations, but BAs and bearer deposit notes will not be accepted by the BoC, effective today.

Characteristics of the other purchase programs stay intact for the moment: “The bank maintains its commitment to continue large-scale asset purchases until the economic recovery is well under way.” Markets definitively perceived the statement as upbeat because of the focus has shifted from containing the magnitude of the recession and market liquidity pressures to support the recovery. Inflation targeting will guide the pace of growth and composition of the BoC’s balance sheet going forward. In our view, one issue Governor Tiff Macklem will need to monitor closely in the coming weeks relates to the increasing cost of doing business for some companies reopening, which started to lead to COVID-19 fees for consumers. A large share of the Canadian CPI basket could be subject to COVID-19 surcharges. As a guideline, the Federal Reserve estimates high contact-intensive industries represent 55% of total U.S. employment. At first glance, we see these as industry-specific price shocks rather than the beginning of a stagflation era, particularly in the context where the lagged effects from the recession and anxious consumers lead to broad disinflationary forces.

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