March 9, 2021
As distance from emergency conditions grows, policy guidance from both the Bank of Canada and the Federal Reserve will probably turn more restrictive in stages that gradually introduce tightened financial conditions as 2021–22 unfolds. To date, both central banks have guided that they will leave their policy rates unchanged until 2023, if not later, while standing by guidance in favour of a prolonged maintenance of asset purchase programs.
The narrative that follows explains how, dependent upon projected recoveries, material policy exit signals are likely to commence well in advance of guidance from these central banks. The BoC is forecast to be the first major central bank to shut down its Government of Canada bond purchase program within the coming year, to accompany this move with other forms of reduced policy accommodation along the way, and to follow that with a rate hike and restoration of the normal operating band of 50bps for the overnight rate by 2022H2. This is consistent with views expressed since November when vaccine trials became a game changer to the outlook, though perhaps not one set on a linear path!
On the back of heavy fiscal stimulus, we also think the Federal Reserve could achieve the goal of hitting its dual mandate with inflation “moderately above 2% for some time” and full employment by the end of next year. This would follow closure of the output gap by the end of this year and move into excess aggregate demand in 2022 based in part upon delivering a total of at least US$2.3 trillion in US fiscal stimulus including the December bill and the Biden Administration’s plans. The path to such an outcome would merit moving away from emergency stimulus by tapering Treasury and MBS purchases by early 2022. This is expected to be preceded by market effects likely later this year that could be substantially different from 2013–14.
Source: Scotia Bank
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