Historically Low Interest Rates Signal Further Economic Despair

Nataly Kehyayan, Staff Writer

Expectedly, the Bank of Canada made the decision to keep interest rates fixed at 0.25% on Wednesday, January 20th. The historically low rates are part of the federal effort towards supporting an economy that has been hit hard by the pandemic. The central bank has forecasted an economic contraction in the coming months. 

The overnight rate that is set by a central bank is an interest rate to direct the monetary policy to maintain inflation stability. Only the most trusted and well-established institutions can borrow money at this rate. This rate influences the economy in multiple ways, as it impacts factors such as inflation, unemployment, mortgages (depending on the type of mortgage), and economic growth. 

Inflation will likely get back on track as products like wheat, lumber and oil keep pushing higher. Therefore, the Bank’s bond purchases will eventually have to be gradually diminished to slow down the rapid acceleration of inflation. These bond buying programs are designed to lower the cost of borrowing for Canadians to help the economy. Interest rates will remain at record lows until inflation is at the target mark of 2% again.

There’s been a deceleration in the country’s recovery pace since COVID-19 cases started surging once more in September. With stricter lockdown restrictions and unemployment rising for the first time in December since April of 2020, gross domestic product is expected to contract 2.5% in Q1 of 2021. A rebound is anticipated in the second quarter as more Canadians are vaccinated and can return to work, stores, and restaurants. 

The forecasted economic growth in 2021 has been adjusted to 4%, down from 4.2% in a previous forecast. The solution to this problem is already in the economy, as Canadians hold sufficient capital to boost the economy. However, consumption has been very heavily restricted and Canadians cannot spend their money freely until the health crisis has been overcome.

Despite the aggressive $4 billion bond purchasing program, the Consumer Price Index has increased only 0.7% since last January, signaling deflationary activity considering the amount of new money entering the economy. This number was 2.2% in 2019, 2% in 2018, and is not expected to return to normal levels until 2023. The Bank also reported the effect COVID-19 had on Canada in 2020, which was a 5.5% overall contraction. 

Head of currencies at BNP Paribas Asset Management, Momtchil Pojarliev, predicts that Canada will have to raise interest rates sooner than other countries as oil prices gain momentum once economies across the world start recovering from the pandemic. With a strong commodity market, the bank will have to take inflation into consideration and take action to keep it under control. However this will not be the case for the next few months as Canadians deal with the impact of the second wave of the pandemic and a much dreaded potential double-dip recession.

Photo by Mathieu Stern, Unsplash

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