Bank of Canada Accelerates Potential Timing of Rate Hikes

(Bloomberg) -- The Bank of Canada ended its bond-buying stimulus program and accelerated the potential timing of future interest rate increases amid worries that supply disruptions are driving up inflation. 

In a statement Wednesday, policymakers led by Governor Tiff Macklem announced they would stop growing holdings of Canadian government bonds, ending a quantitative easing program that has poured hundreds of billions into the financial system since the start of the Covid-19 pandemic.

They also signaled they could be ready to hike borrowing costs as early as April, as supply constraints limit the economy’s ability to grow without fueling inflation.

The Canadian dollar soared and bonds were hit hard. The loonie jumped to C$1.2327 per U.S. dollar as of 12:35 p.m., up more than 0.5%. It rose to as much as C$1.2301 earlier in the day. Two-year benchmark yields rose about 20 basis points to 1.063%.

“We will be considering raising interest rates sooner than we previously thought,” Macklem said at a press conference in Ottawa after the policy decision. “Interest rates don’t need to be as low for as long to get that full recovery and get inflation back.”

Tightening Cycle

Macklem maintained his pledge not to raise the benchmark overnight policy rate until the recovery is complete, but officials now believe that will happen in the “middle quarters” of 2022, rather than the second half of next year as previously thought.

The language will reinforce market expectations the Bank of Canada is poised to quickly pivot to a tightening cycle amid growing price pressures, part of a change of course at central banks globally amid the stronger-than-expected inflation readings. Investors are anticipating the Canadian central bank will start raising interest rates as early as January, with markets pricing in five rate hikes next year.

“Shortages of manufacturing inputs, transportation bottlenecks, and difficulties in matching jobs to workers are limiting the economy’s productive capacity,” policymakers said in the statement. “Although the impact and persistence of these supply factors are hard to quantify, the output gap is likely to be narrower than the bank had forecast.”

What Bloomberg Economics Says...

“Stronger and more persistent inflation pressures drove hawkish adjustments to the Bank of Canada’s policy statement, opening the door to a hike in 2Q 2022 if conditions warrant. Still, we think the shift is difficult to square with the downward adjustments the bank made to its GDP forecasts through 2023.”

-- Andrew Husby, economist

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The Bank of Canada released details of how it will implement the “reinvestment phase” of bond purchases in a market notice. It said it expects to be able to maintain its total stock of government of Canada bonds by purchasing assets of between C$4 billion ($3.2 billion) and C$5 billion per month, from both the primary and secondary markets. This change will take effect Nov. 1.

Macklem has been using two major tools to keep borrowing costs low: maintaining the bank’s policy interest rate near zero and buying up  government bonds to keep longer-term borrowing costs in check.

The benchmark interest rate was left unchanged at 0.25% on Wednesday. The central bank has increased its bond holdings by about C$350 billion since the start of the pandemic.

The more hawkish tone comes even amid a less rosy outlook for the economy. Officials cut growth estimates for both 2021 and 2022, but argued much of that reflects worse-than-expected supply disruptions in the global economy.

Because of those disruptions, the Bank of Canada marked down estimates of “supply” by more than their downward revisions to output. That means it now sees less excess capacity in the economy, and less reason to accommodate demand with cheap borrowing costs.

The build-up of inflationary pressures also appears to be testing the Bank of Canada’s patience. It revised higher its forecasts for consumer price gains -- to 3.4% in both 2021 and 2022. At his press conference, Macklem sought to reassure Canadians the central bank remains focused on bringing inflation back down to its 2% target.

“We know higher prices are challenging for Canadians, making it harder for them to cover their bills,” Macklem said. “It is our job to bring inflation back to target, and I can assure you we will do that.”

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