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UPDATE 2-Canada economic activity heats up, raises focus on BoC easing bond purchases

Julie Gordon
·3 min read

(Recasts on Bank of Canada pressure, adds analyst comments, updates CAD)

By Julie Gordon

OTTAWA, March 2 (Reuters) - Canada's economic growth in the fourth quarter was stronger than expected and it likely rose again in January, boosting speculation that the Bank of Canada will reduce its bond purchases soon.

The economy grew at an annualized rate of 9.6% in the fourth quarter, beating analyst expectations of 7.5%, data from Statistics Canada showed on Tuesday. Real GDP likely climbed 0.5% in January, according to a preliminary estimate.

In response to the COVID-19 pandemic, the central bank last year slashed interest rates to near zero and introduced a large-scale bond buying program - known as quantitative easing - to ensure market liquidity.

"There had been speculation already that they (the Bank of Canada) would start to taper the quantitative easing purchases, at least announce that as soon as April. This just makes it more likely," said Nathan Janzen, senior economist at RBC Economics.

Bank of Canada Governor Tiff Macklem reiterated last week that interest rates will stay at record low levels until into 2023. The next rate decision is on March 10.

Canadian mortgage rates are beginning to inch higher for the first time since before the COVID-19 pandemic, reflecting the spike in long-term bond yields.

But if economic growth remains robust and the output gap closes more quickly than expected, a rate change could also come sooner than 2023, said economists. Money markets see about 50 basis points of tightening already in 2022.

"I think they'll find it difficult to stay on hold (with interest rates) as long as they are guiding," said Derek Holt, vice president of Capital Markets Economics at Scotiabank.

"Macklem just repeated that the output gap won't close until 2023... We have (the output gap) closing by the end of this year or possibly early next year," he added. "So that's why we think the bank hikes in the second half of next year."

The Canadian dollar was trading 0.1% higher at 1.2638 to the greenback, or 79.13 U.S. cents.

Economic activity edged up 0.1% in December, an eighth consecutive increase, but remained about 3.0% below February pre-pandemic levels, StatsCan said.

The Canadian economy posted its largest annual drop on record in 2020, down 5.4% on the year.

Canada has grappled with a harsh second wave of infections in recent months, with populous Ontario and Quebec both imposing strict restrictions in December and January to contain the spread. Those are now being loosened. "This early read on January... is very good news," said Doug Porter, chief economist at BMO Capital Markets. "It suggests that the economy is dealing with this second set of restrictions much better than I think most expected." (Reporting by Julie Gordon in Ottawa, additional reporting by David Ljunggren, Dale Smith, Fergal Smith, Jeff Lewis and Steve Scherer; Editing by Kirsten Donovan and Bernadette Baum)