Investors Seek Clues on Bank of Canada’s Next Taper: Decision Guide
Investors will be looking for fresh hints from the Bank of Canada this week on its next move to reduce emergency levels of monetary stimulus.
The Ottawa-based central bank was among the first from advanced economies to shift to a less expansionary policy in April, when it accelerated the timetable for a possible interest-rate increase and pare back its bond purchases.
While no major change is expected at its Wednesday policy decision, due at 10 a.m., a second taper is widely seen happening at its next decision on July 14, as the expansion accelerates in the second half of the year and the Canadian economy plods toward a full recovery.
There’s an outside risk officials will seek to dampen expectations this week, fearing a more aggressive policy stance could fuel further gains in the Canadian dollar -- the best performer this year among major currencies. But Governor Tiff Macklem refused an opportunity to talk the currency down last month, suggesting he may not see it yet as a major headwind.
“They will be cautiously optimistic on the future,” Royce Mendes, an economist at Canadian Imperial Bank of Commerce, said by phone. That means “they can continue along the path of further tapering of their asset purchases and probably be at a point in late 2022 to start nudging the policy rate higher.”
In April, the Bank of Canada scaled back its weekly purchases of government debt by a quarter to C$3 billion ($2.5 billion). Analysts anticipate that will need to eventually come down to about C$1 billion per week by at least early next year, which would bring the central bank to a neutral pace of purchases where holdings remain unchanged as securities mature.
On the policy rate, economists unanimously predict Macklem will leave it unchanged at 0.25% on Wednesday, and maintain guidance that he won’t raise it until the recovery is complete and inflation is sustainably at 2%.
Wednesday’s policy decision is a statement-only affair with no new forecasts. That’s one reason why economists don’t expect any policy change until July, when a fresh set of projections will be released. Waiting until next month also gives the bank time to reassess incoming economic data, as the nation emerges from a fresh wave of lockdowns.
What Bloomberg Economics Says...
“The Bank of Canada will stand pat this Wednesday, switching to monitoring mode after several key changes at the late-April meeting. ... Though we think a QE taper arrives in July, we do not expect an initial rate hike until 1Q 2023.”
--Andrew Husby, economist
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The Bank of Canada has said it will bring net purchases of bonds to zero before it starts to consider raising its policy rate, with swaps trading suggesting investors are pricing in a 60% chance of a hike over the next 12 months. Three rate hikes over the next two years are fully priced in, which would leave Canada with one of the highest policy rates among advanced economies.
In the U.S., investors aren’t pricing in any rate hike by the Federal Reserve over the next year, and only one over the next two years.
Macklem is right-sizing one of the more aggressive quantitative easing programs relative to the size of its bond market, in an economy also being supported by massive fiscal stimulus from Prime Minister Justin Trudeau’s government.
At its last decision, the Bank of Canada released new forecasts that showed the economy absorbing slack ahead of expectations, by the second half of next year.
Canada’s red-hot housing market is also another reason for policy makers to worry about emergency levels of stimulus.
But there are downside risks.
Since the last policy decision, Canada has been hit harder by winter Covid-19 restrictions than the Bank of Canada had been expecting. The economy went into reverse in April and May, losing 275,000 jobs -- bringing Canada further away from employment levels that Macklem considers a full recovery.
Gross domestic product grew at an annualized rate of 5.6% in the first quarter, below projections, while second-quarter growth appears to also be short of the central bank’s forecasts.
The loonie, which has gained 5.3% against the U.S. dollar this year, could pose a more serious problem. The Bank of Canada may try to prevent its bond tapering from fueling premature rate-hike expectations, at least relative to the Federal Reserve, which could drive the currency even higher.
That could mean Macklem continues to emphasize the central bank’s commitment is not to raise interest rates before the economy fully recovers, and that any future hike would reflect economic conditions at the time.
“I think the Bank of Canada does need to be careful not to preempt the good news ahead by prematurely tightening policy,” Frances Donald, chief economist at Manulife Asset Management, said by phone.
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