The Bank of Canada is poised to pare back its asset purchases amid a stronger-than-expected economic recovery, taking one of the biggest steps yet by a developed country to reduce emergency levels of monetary stimulus.
Governor Tiff Macklem is expected to cut the central bank’s weekly government bond purchases on Wednesday to C$3 billion ($2.4 billion), from the current pace of C$4 billion. Officials may also give clues to whether they expect to bring forward their timeline for interest rate hikes, with current guidance pointing to no move before 2023.
The policy decision, due at 10 a.m. in Ottawa, is a pivotal one for the central bank. Its quantitative easing program is too large given the size of Canada’s bond market. Just on technical grounds, it needs to be pared back as the government’s financing requirements drop.
At the same time, a case is growing for less stimulus. The economy is running at a much faster clip than the Bank of Canada has been projecting, forcing officials to start laying the groundwork for the start of policy normalization.
“The economic outlook has improved markedly since January”, Dominique Lapointe, an economist at Laurentian Bank Securities Inc., said by email. “The Bank of Canada is ready to take its foot off the accelerator.”
Officials won’t want to get too far ahead of other major central banks like the Federal Reserve, which has been wary to talk about scaling back. If the Bank of Canada moves alone, it could trigger a currency appreciation that would be self-defeating.
To be sure, the Bank of Canada’s asset purchases have been more aggressive than others in the Group of Seven, at least relative to the size of the nation’s bond market.
The central bank has bought about C$280 billion in Canadian government bonds over the past year, ballooning its balance sheet to around one-quarter of economic output. It now owns more than 40% of outstanding bonds and is on pace to go above 50% in a few months as Prime Minister Justin Trudeau’s government reduces its issuance by about C$90 billion this year, according to estimates by Ian Pollick, head of fixed income, currency and commodity research at Canadian Imperial Bank of Commerce.
It’s a massive footprint that threatens to create financial distortions -- a concern that led Macklem to reduce minimum weekly purchases in October, from C$5 billion initially. At the time, officials characterized the taper as neutral in terms of stimulus, because they shifted purchases toward long-term bonds concurrently. The more the tapering takes place in the short end of the yield curve -- two-year and three-year bonds -- the less the impact on financial conditions.
“In some ways they’re being forced into a taper,” Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, said by phone.
What Bloomberg Economics Says...
“The economy is working through a third wave of Covid-19 and new restrictions, but the growth and labor market outlooks are still significantly stronger than the BoC envisioned in January, meeting the guideline for a reduction.”
--Andrew Husby, economist
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But the improving economic outlook does give the central bank more scope to pare back now, and policy makers have been clear that a stimulus pullback is coming for reasons beyond those technical issues. The bank laid the ground rules for what that would look like in a speech last month by Deputy Governor Toni Gravelle, who said tapering will be “gradual and in measured steps.”
What the central bank won’t do is touch its short-term benchmark interest rate, its primary monetary policy tool. Economists unanimously see the bank holding it unchanged at 0.25% at the announcement. Not only is the rate at historic lows, but the central bank has pledged not to raise it until all economic slack is full absorbed, so inflation can return sustainably to its 2% target.
When that will be depends on a lot of guess work.
Up until January, when the Bank of Canada last released economic forecasts, it projected that threshold wouldn’t be reached until 2023.
The economy, however, has outperformed spectacularly relative to the Bank of Canada’s projections since then. As a result, markets are anticipating the central bank will bring forward its rate increase, with a 60% probability of a hike this time next year.
There is scope for Macklem to push back against those expectations.
Economic slack is hard to measure and that gives him leeway to argue faster growth doesn’t mean there will be less excess supply. The central bank can also express heightened concern about the uneven recovery in the labor market -- giving it even more discretion. Then there is the seriousness of the current wave of Covid-19 cases, which is the worst so far in parts of the country. That prompted Canada’s largest province, Ontario, to take its most aggressive steps yet to restrict the movement of people last week.
“I think they will keep to this cautious optimism,” Dawn Desjardins, deputy chief economist at Royal Bank of Canada, said by phone.
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