Q: Stephen, it was a tough winter for Canada, involving yet more coronavirus restrictions. How has its economy fared?
A: All things considered, Canada has weathered this storm pretty well. The economy ended up growing three times faster in the fourth quarter than the consensus had expected at the start of the quarter, and it also grew 0.5% month-on-month in January – that suggests this round of virus restrictions didn’t hamper activity as much as the last.
Q: What have been the key drivers of this recovery?
A: Among the pandemic’s many surprises has been the speed of the rebound in oil production. It had fully recovered by December, with Canadian firms taking market share from US producers. So although we had more coronavirus restrictions at the end of last year, the buoyancy of oil prices – and other commodity prices too – have helped offset these, and then some.
Q: What about housing – will the boom continue?
A: The Canadian economy has become far more reliant on the housing market compared with the historical average. Ordinarily, you’d expect policymakers would want to take action but we’re telling clients that much of this activity is being driven by changes wrought by the pandemic – essentially, people want bigger homes as they spend more time working in them. Housing market exuberance is a risk, but we don’t think this justifies higher policy interest rates, as things stand.
Q: So when will the Bank of Canada hike rates?
A: We’re not expecting the Bank to raise its policy rate until 2023. We do see higher bond yields and mortgage rates drifting up and that will help cool the activity. We don't think prices will fall outright – more that house price inflation slows to not much more than 2% by the end of next year from 10% at the start of 2021.
Q: The market is pricing in a rate hike from the BoC next year – why do you think that’s too early?
A: We don’t think market participants fully appreciate just how much the Bank’s reaction function has changed in this crisis. They are overestimating how much the BoC is concerned about inflationary dynamics and not paying enough attention to the voices of people like Governor Tiff Macklem – he’s placing greater emphasis on employment outcomes. This tells us the Bank is prepared to tolerate higher inflation than it might have done in the past because it's taking more account of how the pandemic has affected disparate parts of society.
Published 10 March, 2021
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