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Bank of Canada and the Recent Monetary Policy Decision

June 4, 2020 By Mircea Vasiu

Bank of Canada (BOC) kept the interest rate steady this week at 0.25%, following the RBA decision on Tuesday. Another major central bank keeps the rate close to zero and, additionally, expands the balance sheet via quantitative easing. 

The Canadian policy interest rate level is justified considering the ongoing disinflation (-0.2%) in April 2020 and the low oil price in 2020. While acknowledging that the coronavirus impact on the global economy may have peaked, BOC remains cautious about how the recovery may unfold.

Extraordinary Measures Undertaken by Bank of Canada

Following on the footsteps of other major central banks, BOC undertook extreme measures to stimulate the Canadian economy in the time of the coronavirus. The size of its balance sheet tripled in 2020 in support of the economy and the financial system, reaching about 20% of GDP or CAD460 billion.

For Q2, the BOC estimates that the Canadian GDP will shrink by 10%-20% compared to Q1 2020, albeit the decline is not that sharp as the worst-case scenario stated in the April MPR (Monetary Policy Report).

Commodity prices have a big impact on the way BOC conducts its monetary policy. The price of oil, in particular, as the Canadian economy is an energy-intensive one, and a big part of its workforce is employed in upstream and downstream oil production.

The BOC noticed that, after falling sharply earlier this year, commodity prices have recovered, albeit still remaining low. Canada suffered historic losses in output and jobs due to the coronavirus outbreak, and the targeted fiscal actions combined with lower interest rates provided a buffer against the shutdown. More importantly, BOC’s decisions and actions are meant to lay the foundation for a gradual economic recovery, which is on the mind of every central bank in the developed world.

In 2020, the Canadian Dollar (CAD) was one of the most volatile currencies part of the Forex dashboard. When the price of the May’s WTI  futures contract settled below zero in the second half of April, the CAD had one of its worst periods in history.

As Canada is a major oil producer, the CAD has a direct relationship with the price of oil – it rises and falls following the movements on the price of oil.

The relationship is both a blessing and a curse for BOC – the advantage of having a weaker currency to help exports is offset by the fact that the main export products are derived from oil, priced lower.

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