Bank of Canada plans to raise interest rate before winding down quantitative easing program, Macklem says - The Globe and Mail

Bank of Canada governor Tiff Macklem provided the clearest picture to date about how the central bank plans to reduce monetary stimulus, setting up expectations for a possible cut in government bond purchases in October and saying that the bank expects to start raising interest rates before it entirely winds down its quantitative easing program.

In a Thursday speech, Mr. Macklem said the bank is approaching the “reinvestment phase” of its federal government bond buying program, also known as quantitative easing (QE). Since the start of the pandemic, the bank has been buying billions of dollars worth of government bonds every week in an attempt to lower yields on benchmark bonds and bring down borrowing costs across the economy.

When the bank arrives at the “reinvestment phase,” it will try to match its weekly bond purchases to the pace at which bonds it already owns are maturing – effectively stabilizing the size of the bank’s balance sheet. That will require buying between $4-billion and $5-billion worth of government bonds a month, down from around $2-billion a week, Mr. Macklem said.

He said that once the bank stabilizes its asset purchases, it may look to raise interest rates before further reducing the pace of bond buying.

“Eventually, when we need to reduce the amount of monetary stimulus, you can expect us to begin by raising our policy interest rate. What this all means is it is reasonable to expect that when we reach the reinvestment phase, we will remain there for a period of time, at least until we raise the policy interest rate,” Mr. Macklem said, according to the prepared text of the speech.

The speech comes a day after a rate decision where the bank decided to leave monetary policy unchanged. Most analysts expect the bank’s next reduction in bond buying to come in October. The bank has trimmed the size of the QE program three times since last year, making it one of the most aggressive central banks in the world in terms of cutting back emergency stimulus measures.

Another key detail of the speech was that the bank intends to reduce its purchases of government bonds on both the primary and secondary market. The QE program works by buying assets owned by private financial institutions. Alongside this, the bank also buys bonds straight from the government, mainly to offset banknote liabilities, not as a form of stimulus.

Currently, around 25 per cent of the bank’s weekly government bond purchases are primary market purchases, while 75 per cent are secondary market purchases.

“Much of the focus has understandably been on our large-scale secondary market bond purchases associated with QE. But during the reinvestment phase, we will reduce both our primary market purchases at Government of Canada bond auctions and our purchases in the secondary market. This will keep our total holdings of Government of Canada bonds roughly stable over time,” Mr. Macklem said.

Royce Mendes, senior economist at CIBC Capital Markets, said that Mr. Macklem’s speech was intended to highlight two points.

“First, tapering should not be considered monetary tightening. Rather, having a stable balance sheet should be viewed as maintaining the monetary stimulus already provided via QE, just not increasing it further,” Mr. Mendes wrote in a note to clients.

“Second, the beginning of the reinvestment phase will not necessarily mean that the central bank has changed its view on how long to keep the policy rate pinned down,” Mr. Mendes wrote.

The bank’s key policy rate has been at 0.25 per cent since the start of the pandemic. The bank has promised not to raise the policy rate until slack in the economy is absorbed. It currently estimates this to happen in the second half of 2022.

Alongside new details about the QE program, Mr. Macklem also gave his assessment of the economy, which was in line with the bank’s Wednesday rate announcement.

“The Governing Council continues to expect the economy to strengthen in the second half of 2021, although the fourth wave of COVID-19 infections and ongoing supply bottlenecks could weigh on the recovery,” he said .

Mr. Macklem noted the unexpectedly bad economic growth data Statistics Canada published last week. Statscan determined the economy shrank by 1.1 per cent on an annualized basis in the second quarter, which was 3 percentage points below the central bank’s forecast.

“Growth in the second quarter was affected by disruptions to global supply chains as well as the impact of necessary public health measures,” Mr. Macklem said, noting problems with automobile production and shipping bottlenecks.

“We expect these global supply chain problems will gradually be resolved, but it could take some time.”

On the topic of inflation, he reiterated the view that the recent run-up in prices is largely the result of “transitory” factors, although he said that “their persistence and magnitude are uncertain and we will be monitoring them closely.”

The year-over-year increase in the Consumer Price Index has been above the bank’s target range since May, hitting a decade high of 3.7 per cent in July.

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Bank of Canada plans to raise interest rate before winding down quantitative easing program, Macklem says - The Globe and Mail
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