Why Canadians should be careful borrowing when rates are low
The Bank of Canada could soon start pulling back stimulus from the nation’s surprisingly robust economy, with the first clues on its next moves coming as early as this week.
Economists unanimously predict policy makers led by Governor Tiff Macklem will leave their key interest rate unchanged at 0.25 per cent at a 10 a.m. decision Wednesday in Ottawa. There’s speculation, however, they could signal plans to pare back the central bank’s asset purchases at the next meeting in April.
While Macklem has long indicated such a move would be required once the recovery takes hold, the economy is running at a much faster clip than the Bank of Canada has been projecting -- potentially forcing it into action.
“They’ll need to slow purchases sooner rather than later,” Veronica Clark, economist at Citigroup Global Markets Inc. in New York, said by phone. “It’s a substantial amount of accommodation they’re providing.”
Much has changed since the Bank of Canada’s last decision on Jan. 20, when there was even speculation the central bank could lower its policy rate further to counter a mini downturn.
New lockdowns in winter were less disruptive than feared, and Canada’s vaccine program is rolling out faster than expected two months ago. A massive US$1.9 trillion stimulus plan in the U.S. is also about to super-charge the economy of Canada’s largest trading partner.
Economists have been raising their growth forecasts, with the latest estimates putting Canada’s expansion at 5.4 per cent in 2021 versus a 4 per cent projection by the central bank in January.
There’s no chance of an imminent hike in the policy rate. The bank has said it won’t raise it until economic damage from the pandemic is fully repaired, but investors are starting to pull forward their bets on when that will occur. Markets were pricing in more than a 50 per cent chance of an increase by this time next year at midday Tuesday, up from about 25 per cent odds at the Bank of Canada’s last decision.
But before then, it will start tapering its asset purchases -- equivalent to pulling back the throttle rather than applying brakes.
The Ottawa-based central bank has been buying a minimum of $4 billion (US$3.2 billion) in federal government bonds each week to help keep borrowing costs low. That pace may no longer be warranted with an outlook that appears to show the economy absorbing all excess slack by next year, ahead of the Bank of Canada’s 2023 timeline for closing the so-called output gap.
Wednesday’s statement-only decision limits the central bank’s ability to make major changes, though a speech by Deputy Governor Lawrence Schembri on Thursday could provide hints. Economists see policy makers moving at the April 21 meeting, when the statement comes with a new set of quarterly forecasts along with a press conference from Macklem.
“In April the economy will clearly be in a place where they will be comfortable to actually outright remove some accommodation,” Clark said, adding she expects the bank to reduce weekly bond purchases to $3 billion.
One reason a taper isn’t in the cards until then is because of a heavy maturity schedule in coming weeks, analysts say. The Bank of Canada will need to keep buying at the existing pace simply to maintain its current level of asset holdings.
What Bloomberg Economics Says...
“Another taper in asset purchases (from the current US$4 billion per week) is imminent, but we expect the statement to provide guidance that it is coming in April.”
--Andrew Husby, economist
By April, Justin Trudeau’s government may also have released a new budget that will give the Bank of Canada more information on planned bond sales, another key technical input into how the purchase program will evolve, according to Josh Nye, an economist at Royal Bank of Canada in Toronto.
The central bank wants to avoid taking ownership of too large a share of the outstanding bond market, which means declining issuance will necessitate a reduction in Bank of Canada purchases. Its program was more aggressive than others in the Group of Seven, at least relative to the size of the nation’s market. That’s a key reason why Macklem is expected to pare back again before the Federal Reserve.
It was exactly this concern -- over market distortions -- that drove Macklem to reduce minimum weekly purchases in October, from $5 billion initially. At the time, officials characterized the taper as neutral in terms of stimulus, because they shifted purchases toward long-term bonds at the same time.
The second taper could follow a similar rationale.
“The government won’t be issuing as much debt,” Nye said by phone, and that will require the Bank of Canada “to recalibrate purchases to that level of issuance.”
Still, the outlook also suggests that -- outside of technical reasons -- the central bank will need to pare back stimulus soon.
Macklem has already laid the groundwork. In January, he said the bank would reduce asset purchases once the rebound takes hold, and that was with an economic outlook that’s already proved to be too cautious.
The recent increase in long-term yields globally also makes it easier for the Bank of Canada to move on quantitative easing without shocking the market, according to Ian Pollick at Canadian Imperial Bank of Commerce.
“The move in yields, which is a global impulse, has done a lot of the work,” Pollick, head of fixed income, currency and commodity research at CIBC, said by email.
The message from Macklem has been that the central bank will bring net purchases of Canadian government bonds to zero once the recovery is “well underway.”
At a February press conference, the governor said that’s still “some ways off.” To some economists, the program may not survive the year.