Monetary Policy Report July 2020 Canada’s Infl ation-Control Strategy1 pre-set days during the year, and full updates of the Bank’s Infl ation targeting and the economy outlook, including risks to the projection, are published four . The Bank’s mandate is to conduct monetary policy to promote times per year in the Monetary Policy Report. the economic and nancial well-being of Canadians. Canada’s experience with in ation targeting since 1991 has shown that the best way to foster con dence in the value Infl ation targeting is symmetric and fl exible of money and to contribute to sustained economic growth, . Canada’s in ation-targeting approach is symmetric, which employment gains and improved living standards is by keeping means that the Bank is equally concerned about in ation rising in ation low, stable and predictable. above or falling below the 2 percent target. In 2016, the Government and the Bank of Canada renewed . Canada’s in ation-targeting framework is exible. Typically, Canada’s in ation-control target for a further ve-year period, the Bank seeks to return in ation to target over a horizon of six ending December 31, 2021. The target, as measured by the to eight quarters. However, the most appropriate horizon for consumer price index (CPI), remains at the 2 percent midpoint returning in ation to target will vary depending on the nature of the control range of 1 to 3 percent. and persistence of the shocks buffeting the economy. The monetary policy instrument Monitoring infl ation . The Bank carries out monetary policy through changes in the . In the short run, the prices of certain CPI components can be target for the overnight rate of interest.2 These changes are particularly volatile. These components, as well as changes in transmitted to the economy through their in uence on market indirect taxes such as GST, can cause sizable uctuations in interest rates, domestic asset prices and the exchange rate, CPI. which affect total demand for Canadian goods and services. In setting monetary policy, the Bank seeks to look through The balance between this demand and the economy’s such transitory movements in CPI in ation and focuses production capacity is, over time, the primary determinant of on a set of “core” in ation measures that better re ect the in ation pressures in the economy. underlying trend of in ation. In this sense, these measures . Monetary policy actions take time—usually from six to eight act as an operational guide to help the Bank achieve the CPI quarters—to work their way through the economy and have in ation target. They are not a replacement for CPI in ation. their full effect on in ation. For this reason, monetary policy . The Bank’s three preferred measures of core in ation are CPI- must be forward-looking. trim, which excludes CPI components whose rates of change . Consistent with its commitment to clear, transparent in a given month are the most extreme; CPI-median, which communications, the Bank regularly reports its perspective on corresponds to the price change located at the 50th percentile the forces at work on the economy and their implications for (in terms of basket weight) of the distribution of price changes; in ation. The Monetary Policy Report is a key element of this and CPI-common, which uses a statistical procedure to track approach. Policy decisions are typically announced on eight common price changes across categories in the CPI basket. 1 See Joint Statement of the Government of Canada and the Bank of Canada on the Renewal of the In ation-Control Target (October 24, 2016) and Renewal of the In ation-Control Target: Background Information—October 2016, which are both available on the Bank’s website. 2 When interest rates are at very low levels, the Bank has at its disposal a suite of extraordinary policy measures that could be used to provide additional monetary stimulus and/or improve credit market conditions. The Framework for Conducting Monetary Policy at Low Interest Rates, available on the Bank’s website, describes these measures and the principles guiding their use. The Monetary Policy Report is available on the Bank of Canada’s website at bankofcanada.ca. For further information, contact: Telephone: 613-782-8111; 1-800-303-1282 (toll-free in North America) Public Information Email: [email protected] Website: bankofcanada.ca Communications Department Bank of Canada ISSN 1201-8783 (Print) 234 Wellington Street ISSN 1490-1234 (Online) Ottawa, Ontario K1A 0G9 © Bank of Canada 2020 Monetary Policy Report July 2020 This is a report of the Governing Council of the Bank of Canada: Tiff Macklem, Carolyn A. Wilkins, Timothy Lane, Lawrence Schembri, Paul Beaudry and Toni Gravelle. Contents Overview . 1 A central scenario is provided rather than a projection . 2 Global economy . 5 The global economic contraction was sharp and sudden . 6 Growth is picking up as economies reopen . 7 Demand is expected to remain weak relative to supply . 8 Policy actions continue to provide support . 8 Commodity prices have partially rebounded . 9 Canadian economy . 11 Box 1: Key inputs to the central scenario . 12 Fiscal and monetary authorities responded swiftly . 13 The reopening phase of the recovery is underway . 14 CPI inflation has fallen sharply . 16 Box 2: Adjusted CPI inflation shows only slightly less decline than CPI inflation . 18 Growth moderates in the recuperation phase . 19 Household spending will rise, but caution may linger . 20 Business investment is likely to remain weak . 22 The energy sector is expected to remain subdued . 22 Exports will recover at a moderate pace . 23 A slow rebound in demand weighs on inflation . 23 Box 3: Estimating the economy’s supply in the wake of COVID-19 . 24 Monetary policy tools . 27 Alternative scenarios and risks . 29 OVERVIEW BANK OF CANADA • MONETARY POLICY REPORt • JulY 2020 1 Overview The COVID-19 pandemic has caused a worldwide health-care emergency as well as an economic calamity. Both are on a scale few have seen in their lifetime. The virus has spread broadly and rapidly, and to contain it, governments introduced public health measures that curtailed economic activity. The virus, combined with these necessary measures, has brought about the steepest and deepest economic decline since the Great Depression. Virtually every aspect of the Canadian and global economies has been affected, causing widespread losses in jobs and business incomes. The course of the pandemic is inherently unknowable, and its evolution over time and across regions remains highly uncertain. New cases of the virus are now at very low levels in China, but many other emerging- market economies (EMEs) are now seeing their number of new cases increase rapidly (Chart 1). Some advanced economies that were hard-hit at the outset have slowed the rise in new cases and are reopening their economies. In the United States, infections have reached new highs. Globally, hundreds of thousands of lives have been lost. Chart 1: The course of the pandemic remains highly uncertain Daily new cases per million people, 7-day moving average a. Advanced economies b. Emerging-market economies Number of cases Number of cases 200 200 150 150 100 100 50 50 0 0 0 30 60 90 120 150 0 30 60 90 120 150 Number of days Number of days Canada Euro area United Kingdom Mexico Russia South Africa United States Japan India China Brazil Note: The fi rst occurrence along the bottom axis corresponds to the fi rst day when the number of new cases per million people is greater than one. Sources: World Health Organization via Haver Analytics, UK Department of Health and Social Care, Public Health England and Bank of Canada calculations Last observation: July 10, 2020 OVERVIEW 2 BANK OF CANADA • MONETARY POLICY REPORt • JulY 2020 Figure 1: The recovery in economic activity and household spending follows two phases: reopening and recuperation Containment Recuperation Reopening Time In Canada, the number of new COVID-19 cases has fallen sharply from its April high, and the economic recovery has begun in all provinces and territories and across many sectors. Consequently, economic activity is picking up notably as measures to contain the virus are relaxed. This is a welcome sign. The Bank of Canada expects a sharp rebound in economic activity in the reopening phase of the recovery, followed by a more prolonged recuperation phase, which will be uneven across regions and sectors (Figure 1). As a result, Canada’s economic output will likely take some time to return to its pre-COVID-19 level. Many workers and businesses can expect to face an extended period of difficulty. A central scenario is provided rather than a projection The economic outlook is extremely uncertain, largely because of the unpredictable course of the virus. Reflecting this, the July Monetary Policy Report provides a central scenario for the economy rather than the usual economic projection. The central scenario is informed by the Bank’s analysis and tries to balance the likelihood of better and worse scenarios, but it is highly conditional on our assumptions about the virus. In particular, the central scenario assumes the following: there will not be a broad-based second wave of the pandemic in Canada or globally; most large-scale containment measures will be gradually lifted; and the pandemic will have largely run its course by mid-2022, likely because of the widespread availability of a vaccine or effective treatment. In addition to the fundamental uncertainty about the course of the virus, there is also considerable uncertainty about its impacts. In particular, there is not enough information to estimate how deeply the economy may be scarred from business closures or massive job losses.