It's Going to Take a While for Things to Get Back to Normal
It’s no secret how much COVID has changed the world and its economy. While some people might overestimate the real damage, it’s still there. Sure, innovation has been rampant this year. Many businesses have actually improved in 2020 when it comes to operations.
However, we’re still far from how we used to be before the virus. A great example is Canada, for it’s been able to withstand COVID’s damage, yet it’s still far from ideal. For instance, the Bank of Canada has stated that it might be long before things go back to normal.
How much is “long”? Well, the BoC believes 2023 might be the year. As dire as it may sound for some, it’s actually quite good. We’re not saying that the Canadian economy is stagnant—quite the contrary.
Canada has been recovering steadily, but somewhat slowly. That means things are mostly looking up until 2023.
What has Canada done to curb the virus’ damage? What’s backing up the 2023 prediction?
BoC Suggests It'll Take Until 2033 for Complete Recovery
Now, we don’t want to underestimate the real extent of the damage over the Canadian economy. As Bloomberg reports, it’s comparable to the Great Depression. That’s why it’s called for strong measures, mainly related to interest rates.
That’s actually the main focus of the article we mentioned: how the BoC has leveraged interest rates to spur financial stability. It essentially offsets the costs brought by COVID, lockdowns, and overall economic downturn.
This measure is most likely going to remain until reaching a couple of milestones. Mainly, the BoC aims to keep inflation under their sustainable target. It’s also vital to encourage employment so that the rates can go back to pre-COVID levels.
Luckily, quarterly reports have been quite positive. Even the Q4 report shows optimistic momentum in terms of loss absorption.
Interest Rates Are at an All-Time Low
The most interesting side of the BoC’s approach is its commitment to low interest rates. The bank’s overnight rate settled with 0.25%. According to authorities, it’s as low as it can get, yet the commitment is for the long-term as well. The plan is to keep this rate until inflation becomes sustainable.
It’s easily the most important move by the bank, as it shows it’s not shy of doing whatever it can to minimize the virus’ financial effects. However, the long-term commitment has an expected secondary effect. They also hope for the low-interest certainty to motivate spending and borrowing.
Governor Tiff Macklem considers that, and the unusual transparency around interest rates and their plan, to be vital for the country’s growth. In fact, the Canadian dollar has risen amidst this implementation.
Given how vital financial aid has been for other regions, lowering interest rates for the long term might have a similar—if not better—outcome. That’s because of its main impact on investments and entrepreneurship.
The Goal Behind: Controlling Inflation
The main objective behind these interest rates is to stabilize the economy, which is obvious. However, the main sign for this recovery appears to be inflation levels. More specifically, Macklem claimed that these rates shall remain until 2% inflation—the sustainable target—is reached.
That said, it’s also a positive outlook for unemployment as well. It’s been at an historical high level, in its 12%. The main reason behind it is the number of companies that had to shut down operations because of the lockdowns. However, reaching a 2% inflation rate depends on improving operations, thus reducing unemployment.
It’s worth noting that the governor himself hasn’t offered an expected period for this achievement. He simply stated that the bank needs evidence of the desired loss absorption with this policy. Nevertheless, he did mention that the 0.25% is likely to remain for a couple of years.
We also need to keep in mind professional projections. Several sources have estimated inflation to sit around 1.3% for 2021 and 1.8% the year after.
It’s also worth noting that Canadian’s lack access to said interest rate, yet only directly. That’s because the policy affects how much businesses and households have to pay for their loans.
Commercial banks’ interest rates tend to be a couple of percentage points over this policy. That means it’s a significant incentive for businesses.
How Has it Impacted the Bank?
Needless to say, it’s not a common situation for the BoC to find themselves in. Only the near-zero interest rates are enough to measure the impact of the COVID crisis on the bank. However, we also need to consider the financial stimuli for different markets, and buying government bonds on a large scale.
The latter is particularly important, for the bank has repeatedly stated its goal of buying a CAD$5 billion minimum every week in government bonds. It follows the same rate-freezing strategy. That said, the governor also expects recovery to reach said level before full economic recovery. It suggests asset re-purchasing might come before raising interest rates again.
Naturally, the bank needs to protect itself during the crisis. This strategy makes a solid transition from medium-term sacrifice to long-term recovery. The main goal is to ease financial stress first to stimulate monetary flow. This type of forward guidance is also adopted by England and the EU’s central banks.
Thankfully, it’s not completely unknown as a territory for the BoC. Forward guidance was also vital for the recession back in 2009.
What do we Think?
Primarily, the dip in interest rates is an interesting, and promising, approach to financial relief. It appears to be an effective alternative to direct government assistance, which encourages companies and households to leverage investment opportunities.
Given the mentioned statistics for the next couple of years, 2023 appears to be the safest bet until pre-COVID recovery. However, we wouldn’t be too surprised if that goal comes a year before what’s expected.
In the end, the BoC’s forward guidance appears to follow the right steps. It incentivizes production and financial activity instead of providing direct relief.
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