Bank of Canada to cut bond buying: decision-day guide
Bank of Canada set to cut back on asset purchases amid a stronger-than-expected economic recovery, taking one of the most important steps ever taken by a developed country to reduce levels of emergency measures monetary stimulus.
Governor Tiff Macklem is expected to cut weekly central bank government bond purchases on Wednesday to C $ 3 billion ($ 2.4 billion) from C $ 4 billion today. Officials can also give clues as to whether they plan to advance their timeline for interest rate hikes, with current forecasts indicating there is no move until 2023.
The political decision, which must be taken at 10 a.m. in Ottawa, is crucial for the central bank. Its quantitative easing program is too big given the size of the Canadian bond market. For technical reasons alone, it must be reduced as the government’s funding needs decrease.
At the same time, a case develops for less stimulus. The economy is spinning at a much faster pace than the Bank of Canada predicted, forcing officials to start laying the groundwork for the start of policy standardization.
“The economic outlook has improved markedly since January”, Dominique Lapointe, economist at Laurentian Bank Securities Inc., said via email. “The Bank of Canada is ready to ditch the accelerator.”
Officials won’t want to get too far ahead of other big central banks like the Federal Reserve, which he was reluctant to talk about reduction. If the Bank of Canada acts 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 country’s bond market.
The central bank bought about C $ 280 billion in Canadian government bonds in the past year, bringing its balance sheet to about a quarter of economic output. It now owns over 40% of outstanding bonds and is on track to surpass 50% in a few months under the leadership of Prime Minister Justin Trudeau’s government cut its issuance by about C $ 90 billion this year, according to estimates by Ian Pollick, head of fixed income, currencies and commodities research at Canadian Imperial Bank of Commerce.
It’s a massive footprint that threatens to create financial distortions – a concern that led Macklem to cut minimum weekly purchases in October, by C $ 5 billion initially. At the time, officials characterized the typing as neutral in terms of stimulus, as they simultaneously shifted buying to long-term bonds. The more the tapering takes place in the short end of the yield curve – two- and three-year bonds – the less the impact on financial conditions.
“In some ways, they’re being forced down,” Benjamin Reitzes, Canadian rate and macro strategist at BMO Capital Markets said by phone.
What Bloomberg Economics Says …
“The economy is operating through a third wave of Covid-19 and further restrictions, but the outlook for growth and the labor market is 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 gives the central bank more leeway to shrink now, and policymakers have made it clear that a pullback in stimulus is happening for reasons beyond these technical issues. The bank put the ground rules for what that would look like in a speech last month by Deputy Governor Toni Gravelle, who said the phase-down would be “gradual and in measured steps.”
What the central bank will not do is touch its benchmark short-term interest rate, its main tool of monetary policy. Economists unanimously see the bank keep it unchanged at 0.25% on the announcement. Not only is the rate at historically low levels, but the central bank has pledged not to raise it until the economic slowdown is completely absorbed, so that inflation can return to its 2% target on a sustainable basis. .
When will it be depends on a lot of guesswork.
Until January, when the Bank of Canada last released its economic forecast, it predicted that this threshold would not be reached until 2023.
The economy, however, has Since then, dramatically outperformed Bank of Canada projections. As a result, markets expect the central bank to advance its rate hike, with a 60% chance of a hike this time around next year.
Macklem has the opportunity to push back those expectations.
The economic slack is difficult to measure and this gives him leeway to say that faster growth does not mean there will be less oversupply. The central bank may also express increased concern over the uneven recovery of the labor market – which gives it even more discretion. Then there is the severity of the current wave of Covid-19 cases, which is the worst to date in parts of the country. This prompted Canada’s largest province, Ontario, to take the most steps restrict the movement of people last week.
“I think they will keep this cautious optimism,” says Dawn Desjardins, deputy chief economist at Royal Bank of Canada said by phone.
– With the help of Shelly Hagan