Bank of Canada Maintains Overnight Rate, Forecasts Recovery

Photo: David Kawai

The Bank of Canada last published a Monetary Policy Report on January 22nd. Although it came out just 84 days ago, it reads like a parchment scroll from antiquity. It does not include the words "COVID," "virus," or "outbreak." It predicts that growth in the Canadian economy will accelerate in 2020. To say the least, it was due for an update.

This morning, the Bank of Canada announced that it would hold its overnight rate at 0.25% and start using new tools to preserve market functionality and lay the groundwork for a recovery. Most notably, the Bank will begin to purchase $50 billion of provincial bonds and $10 billion of investment-grade corporate bonds. This quantitative easing follows the footsteps of the US Federal Reserve, which announced plans to buy up to $2.3 trillion of debt.

Read the new Monetary Policy Report here.

Read the press release here.

Two Significant Shocks to Canadian Economy

The Monetary Policy Report breaks down the challenges the Canadian economy is facing into to related shocks: COVID-19's effect on "economic activity and employment," and the plunge in global oil prices. The two are related, as oil prices were intentionally tanked as belligerents in a price war took advantage of the drop in demand.

The decline in economic activity is obvious and probably something you have witnessed for yourself. Whole sectors of the economy have been shut down, and roughly a million Canadians have lost their jobs. Traffic of all kinds is down and retail stores are boarded up. Stats Canada is estimating that March saw a 9% decline in economic activity.

The decline in oil prices has had a similar effect: businesses have laid off or reduced the hours of thousands of staff. The total rig count, or the number of active oil rigs in Canada, has declined precipitously in 2020, falling from 150 at the start of the year to just under half that in April:

 Source: Monetary Policy Report

Rig count declining is the oil and gas equivalent of boarding up retail stores. Those rigs aren't being ordered to shut down because of COVID-19, but they can't operate economically while oil prices are this low.

What Will Recovery Look Like?

The most interesting section of the Monetary Policy Report details how the Bank of Canada projects the recovery from COVID-19 proceeding. 

We don't have a good historical example to reference, since none of the recessions we have experienced recently were caused by a shock to human health and safety. For example, it took years after the Global Financial Crisis for consumer and business confidence to recover: consumers were hesitant to spend their savings and business owners were hesitant to expand their operations. We don't expect that to be the case here: once the effects of COVID-19 subside and the virus is contained, it won't be difficult to convince business owners to hire employees and begin operating again as soon as they can. With a risk as specific as COVID-19 dominating the outlook, specific changes can cause the outlook to change quickly.

That's not to say that the recovery will be all sunshine and roses. If control measures are in place for a long time, the impact on businesses and households will be more severe. Businesses that are currently boarded up temporarily could become boarded up permanently. Institutional knowledge could erode and neglected property, plants, and equipment could degrade. In short, there could be structural damage to Canada's productive capacity if control measures are in place for too long, and that damage would take years to repair.

There are therefore a range of possibilities for the recovery, depending how quickly controls can be safely lifted and how much structural damage is done before then:

 Source: Monetary Policy Report

That's a wide range, with over a quarter trillion dollars difference between the low points of the extreme scenarios. It all hinges on how quickly the economy can be safely reopened, and how quickly consumer and business confidence can be restored.

Cash Management

Since the overnight lending rate is already at the effective lower bound, we don't expect further cuts from the Bank of Canada in the near term. As banks and credit unions try and bolster their deposits for the volatility ahead, they're offering competitive rates on fixed GICs. Clients with enough liquidity should consider locking up a portion of their portfolio to take advantage of those rates.

We're also advising our clients to invest a portion of their portfolios in Treasury Bills, which offer the lowest level of risk and act as an insurance policy. The return on these investments is much lower than GICs or other deposits, but the risk is much lower. While maximizing yield is important, our priority right now is protecting capital. We can start chasing returns once this volatility has abated.

If you'd like to talk about these events or discuss your portfolio, don't hesitate to reach out to us at 604.643.0101.

Disclaimer: Canaccord Genuity Corp. is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and Canadian Investor Protection Fund (CIPF). The comments and opinions expressed in this commentary are solely the work of the Cash Management Group and Andrew Johns.

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