Bank of Canada forecasts decline in GDP of 7.8% this year

The Bank of Canada will keep its key interest rate at 0.25 per cent until the national economic picture improves, which governor Tiff Macklem said Wednesday will take "a long time."

Low interest rates are meant to help households and businesses recover from the COVID-19 pandemic by making borrowing relatively inexpensive.

Macklem noted the unusual clarity the central bank provided on the path for its key rate, owing to the unusual level of uncertainty facing Canadians worried about their health and jobs.

What the bank expects is a quick but partial economic bounceback from the lifting of lockdowns, giving way to a slower, bumpier recuperation phase.

In its updated economic outlook released Wednesday, the bank expects the economy to contract by 7.8 per cent this year, driven downward by a year-over-year contraction of 14.6 per cent in the second quarter. Then it expects growth of 5.1 per cent in 2021.

Both figures are less rosy than those the Trudeau Liberals relied on in their economic update released one week ago.

The Bank of Canada report pegged the annual inflation rate at 0.6 per cent this year, rising to 1.2 per cent in 2021 and 1.7 per cent in 2022.

Until inflation reaches the bank's target of two per cent, the interest rate won't move, Macklem said.

"Canadians, Canadian businesses are facing an unusual amount of uncertainty, so we have been unusually clear about the future path for interest rates," Macklem said.

"If you've got a mortgage, or if you're considering to make a major purchase, or you're a business and you're considering making an investment, you can be confident that interest rates will be low for a long time."

But the governor was quick to caution the forecasts could easily be thrown off: by a severe second wave of the pandemic, by restrictions that remain in place beyond the end of the year, or by a delay (or surprise advance) in the development of a COVID-19 vaccine or effective treatment.

He looked to the fall as another potential issue, saying that the bank's "central planning scenario" could be hampered if schools and daycares only partially reopen — leaving parents, particularly mothers, to choose between work and child care.

"Families are facing real challenges," Macklem said during a late-morning press conference.

"Hopefully as this virus progresses, we get better and better at managing it and I certainly hope we can find a way to reopen schools and get daycares back to work."

The rate announcement and outlook are the first Macklem has been directly involved in since taking over as governor last month.

The Bank of Canada's June interest rate announcement came on Macklem's first day on the job. Though he was only an observer during the June round of deliberations by the bank's governing council, he endorsed last month's rate hold.

The key interest rate has been at 0.25 per cent since March, when the central bank cut it sharply in response to the economic harm from COVID-19.

The bank followed with an unprecedented purchasing program, including $5 billion of federal bonds weekly that Macklem said would also continue until the economy recovers.

Scotiabank's Derek Holt noted that could mean $215 billion more bond purchases through to next May, and more thereafter if a recovery doesn't arrive by 2023 as the central bank anticipates.

"I'm not sure that the markets can handle that over time without courting risk of market dysfunction," Holt wrote in a research note. He said the purchases — effectively ultra-low-cost lending to the federal government— could also limit the bank's "potential firepower should subsequent shocks emerge."

Although the bank believes the country has been spared from a worst-case scenario envisioned by the bank in April, the outlook suggests output will be four per cent lower in 2022 than envisioned pre-pandemic.

"So even when the economy has recovered to 'full capacity' — which, again, the (bank) doesn't see until at least 2023 — GDP will be notably smaller than the previous trajectory we were on," RBC senior economist Josh Nye wrote in a note.

The central bank's economic outlook warned some lower-income workers, disproportionately affected by job losses or cuts in earnings, "will face prolonged income losses" and push more households to the financial brink.

While higher-income households may have savings they spend now, the report said some households will prioritize paying down debts and padding rainy-day funds due to the uncertain economic environment.

The bank noted housing activity is also expected to slow over the next few years with the ripple effects of the downturn, and lower immigration.

The Bank of Canada will provide a more detailed analysis of its long-run assumptions for the domestic economy when it updates its outlook in late October. The next scheduled rate announcement is Sept. 9.

This report by The Canadian Press was first published July 15, 2020.