Canada shows stronger consumer confidence due to vaccination. How will the central bank react?

It looks like massive vaccination against COVID-19 has led to a stronger consumer confidence in Canada.

According to the recent survey by Nanos Research Group for Bloomberg News, almost 45% of respondents expect the national economy to be stronger over the next six months. It’s the largest number since 2009, pushing the overall confidence index to a record high of 64.6.

While large parts of Canada are still under COVID-19 restrictions, opinion on the economic outlook has improved in May, as more Canadians get vaccinated. In addition to it, we can see the U.S. economy reopening.

In case of job security, the sentiment almost hasn’t changed with about 70% of Canadians saying their employment is at least partially secure.

CIBC believes the Bank of Canada may need to change its view on the long-term neutral policy rate as soon as a wave of increased household savings breaks down, following the restrictions lift.

According to the CIBC Senior Economist Royce Mendes, an unexpected increase in consumer spending and any inflation which may be caused by it could make the BoC take a more thorough look at where the neutral rate should be in the longer term.

The neutral rate is where the interest rate has to be in order to keep the national economy functioning at full potential while keeping the inflation under control. As a rule, full employment leads to a stricter cycle, as the Bank of Canada changes the rates to avoid bubbles in asset categories, e.g. real estate. The central bank’s current long-term view has the neutral policy rate of 2.25%.

Although the calculation of the neutral rate is consistent with cyclical shocks to the economy, Mendes says the unprecedented conditions created by the pandemic may lead to long-lasting consequences and a change in the BoC’s standard methodology.

“Don’t forget that the Bank’s own data shows that Canadians mostly saved money only because they didn’t have a possibility to spend it, and not due to their savings habits”.

According to Mendes, while excess savings may hypothetically be spent on imported goods, decreasing the odds of overheating the economy, it will still hardly reduce the inflationary pressures.

“In case the excess savings were only a Canadian thing, the extra spending over the next years could have been absorbed by growing imports. That could help Canada avoid economic overheating,” – he noted.

“However, if other countries are facing the same issues, there is no exit for extra demand in Canada, as the additional foreign demand will just return to us.”