Good morning, Mr. Chairman and members of the committee. This is the first time that I have addressed this committee since I was appointed Governor of the Bank of Canada, and I am very happy to be here. We view these appearances as an important part of our responsibility to Canadians, and I look forward to your questions and views.
To begin with, I would like to review for the committee the actions of the Bank of Canada since the start of the pandemic. I will also provide our assessment of progress towards economic recovery.
During the pandemic, the Bank of Canada pursued two overarching objectives. At the onset of the crisis, our aim was to restore the functioning of financial markets and maintain the flow of credit. As the market function improved and Canadians began to emerge from the first lockdown, we focused on stimulating monetary policy to support the recovery, get Canadians back to work and bring inflation back to our target of 2%.
Fifteen months ago, the extreme uncertainty caused by the virus and the associated bottlenecks sparked an unprecedented race for liquidity in the financial markets. With many more sellers of financial assets than buyers, credit markets froze, threatening access to credit for businesses and households. The Bank of Canada acted quickly and on a large scale, providing liquidity and purchasing assets to support the functioning of major Canadian financial markets. As a result, the Bank’s balance sheet grew rapidly through the purchase of federal, provincial and corporate bonds, commercial paper, bankers’ acceptances and mortgage bonds.
These new programs, 11 in total, have succeeded in restoring the proper functioning of financial markets. Today, all but one of our exceptional programs have ended or ceased operations. The only remaining program is our purchases of Government of Canada bonds, also known as quantitative easing or quantitative easing, and I’ll get to that in a moment.
To provide monetary stimulus, the Bank lowered our key interest rate as much as we actually could, to 0.25%, in the spring of 2020. Over the summer, we added exceptional forward guidance, committing ourselves to keep our key rate at its effective lower limit. until the slack is absorbed in order to sustainably reach our inflation target of 2%. This commitment was complemented and reinforced by our quantitative easing program, which helps lower interest rates across the entire yield curve, making borrowing cheaper for households and businesses.
In April 2021, the Bank published our revised outlook for the Canadian economy in the Monetary Policy Report (MPR), and economic developments since then have broadly been in line with this outlook. I would like to highlight three key messages.
First, the economic recovery is progressing well. Canadian households and businesses have shown impressive resilience in the face of the pandemic, and with more Canadians vaccinated, we expect better times to come.
Second, full recovery will still take some time. The third wave of the virus was a setback. It has strained health systems in some areas and again hit areas where physical distancing is difficult. Significant parts of the economy remain very small and too many Canadians are still unemployed.
Third, the Bank remains steadfast in its commitment to supporting Canadian households and businesses throughout the recovery. For Canadian workers, a full recovery means a healthy labor market with good opportunities. And that includes low-wage workers, women and young people who have been hit hard by this pandemic. A full recovery means companies are confident the pandemic is over and are investing to seize new business opportunities. And for households and businesses alike, a full recovery means they can count on sustained inflation at our 2% target. Allow me to expand on these themes.
After a sharp rebound in economic activity in the fall and winter, we again saw a slowdown in growth in the second quarter of 2021. Renewed closures associated with the third wave of the pandemic have dampened growth. economic activity at the start of the quarter, largely as expected. The ebb and flow of the virus is reflected in the ebb and flow of economic growth. Recent employment data shows that workers in contact-sensitive sectors remain the most affected and the employment rate remains well below its pre-pandemic level. Yet we have seen impressive resilience and adaptability on the part of Canadian households and businesses. They’ve found new ways to shop, serve customers, and work remotely.
Demand for housing has been particularly strong, driven in large part by the desire for more living space and low mortgage rates. All the while, the limited supply has resulted in a sharp increase in prices. As we explained in our May Financial system review, it is important to understand that the recent rapid increases in house prices are not normal. Our analysis suggests that in some markets price expectations have become extrapolative, meaning people may rush to buy in part because they expect prices to continue to rise. This behavior can exaggerate short-term house price increases relative to fundamental demand. There are also risks that some households may overburden financially.
We welcome the revisions to Guideline B-20 issued by the Office of the Superintendent of Financial Institutions, which amended the minimum qualifying rate, as well as the parallel changes in the insured market. These changes should help protect Canadians from overwork. The federal budget also included measures that will increase supply. Overall, we expect the housing market to be more balanced, but we will continue to monitor this area closely.
Looking more broadly at the economy as a whole, we expect strong consumer-led growth in the second half of this year as vaccinations advance and restrictions ease. Federal and provincial government fiscal stimulus will also make a significant contribution to growth. Strong foreign demand and rising commodity prices are expected to boost exports and business investment, leading to a more widespread recovery. In our April MPR, we forecast the economy to grow by around 6½% this year, around 3¾% in 2022 and 3¼% in 2023.
With these improved prospects, we hope that the pandemic will eventually cause less scarring in the workforce and less loss of capacity than we previously feared. We have therefore revised upwards our estimate of the economy’s potential output. But I want to stress that there is a great deal of uncertainty surrounding this estimate. As the recovery continues, we will be paying attention to a wide range of indicators of underutilization, including a range of labor market measures.
Our monetary policy remains anchored in our inflation targeting framework. The most recent data shows that inflation remained above 3% in May. Inflation will likely stay near the top of our inflation-control target range of 1-3% throughout the summer. This largely reflects the effects of the base year combined with much higher gasoline prices. As these base year effects wear off, the Governing Council expects persistent oversupply in the economy to push inflation down. In our last policy announcement last week, the Governing Council said the economy still needs extraordinary monetary policy support. We remain committed to keeping the key interest rate at the effective lower limit until the economic downturn is absorbed so that the 2% inflation target can be reached on a sustainable basis. Based on our latest projections, this is expected to happen in the second half of 2022, although this timeline is unusually uncertain given the difficulties in assessing the economy’s supply capacity.
Our key rate forecast continues to be strengthened and complemented by the Bank’s quantitative easing program. In April, we adjusted our weekly Government of Canada bond purchases to a target of $ 3 billion, down from the previous low of $ 4 billion. This adjustment reflects the progress we have already seen towards economic recovery.
With the end of most of our extraordinary programs, the bank’s balance sheet has shrunk by about $ 475 billion from a peak of about $ 575 billion in March. Below you will see a graph that shows the evolution of the size and composition of our balance sheet. The Bank currently holds over $ 350 billion in Government of Canada bonds, which represents approximately 45% of nominal bond outstanding.
Going forward, further adjustments to the pace of net buying will be guided by our continued assessment of the strength and sustainability of the economic recovery. If the recovery moves in line with or stronger than our last projection, the economy will not need as much QE stimulus over time. Further adjustments to our quantitative easing program will be incremental and we will be deliberate both in our assessment of incoming data and in communicating our analysis.
We remain committed to providing the appropriate degree of monetary policy stimulus to support the recovery and meet the inflation target.
With that, let me stop and turn to you for questions.