MNI EXCLUSIVE: Slack Keeps BOC Aim on Stimulus Amid Taper Talk

The Bank of Canada remains gloomy about the economy and determined to provide significant stimulus for some time yet, despite indicating that it may soon start reducing its bond purchases under its quantitative easing program.

While investors expect the BOC to cut weekly purchases by a quarter to CAD3 billion at its April meeting, after the economy did better than expected during a second-wave Covid lockdown, the mood at the Bank remains cautious, with a coming spike in inflation due to a recovery in gasoline prices from last year's lows seen as temporary given labor market slack.

In a March 23 speech, Deputy Governor Toni Gravelle sketched out the BOC's approach to tapering, saying it could gradually stabilize its balance sheet with a new pace of purchases and by reinvesting maturing assets. But he insisted that lower purchases will continue to add stimulus to the economy and noted that even when they are eventually cut to a net zero central bank support would be maintained rather than be reduced.

Slower federal bond purchases by the Bank of Canada would continue to hold down yields across the curve to boost the economy. Last year it tapered QE to at least CAD4 billion a week from CAD5 billion, while arguing a shift into longer-term assets was better targeting borrowing rates seen by homebuyers and companies.

STIMULUS TO REMAIN

"If you don't reduce the size of your balance sheet, you're not removing stimulus," Charles St-Arnaud, chief economist at Credit Union Central Alberta and a former central bank and finance department analyst said. "Does it still make sense to buy four billion of bonds a week when the economy is recovering, when we know the second wave of Covid actually didn't lead to an economic contraction?"

Slack in the job market will also restrain inflation, even after an increase in coming months because of last year's tumble in gasoline prices. Canada reported a record 1.5 million people on jobless benefits in January and a quarter of those have fallen into long-term unemployment.

Inflation will likely need until 2023 before stabilizing around the 2% target, the BOC thinks, and Governor Tiff Macklem has said the 0.25% policy interest rate will remain in place until then. Some investors are betting a rate increase will come in the second half of next year instead as vaccines return the economy to normal.

The BOC is also aware of investor concerns that it may end up owning half of federal government bonds, with Gravelle noting that it stands out from other central banks by amassing 35% of the outstanding total. Governor Macklem last year told lawmakers there is some evidence of frictions around the 50% mark, though he also noted some research suggests the figure could go higher.

The BOC's balance sheet has risen to a record CAD575 billion, from CAD548 billion at the end of last year, although it is set to shrink to CAD475 billion by the end of April as repos bought last year to calm markets roll off.

Source: Bank of Canada

The government bond supply could also shift two days day before the BOC's April decision, with Finance Minister Chrystia Freeland presenting a budget expected to detail an extra CAD70 billion to CAD100 billion of deficit spending to regain the million jobs lost in the pandemic. There is some speculation in Ottawa Prime Minister Justin Trudeau could use the budget to unveil even bigger spending plans before calling a snap election.

The Bank may taper but keep the focus on stimulus "for some time" because "the recession has been very deep," said Craig Alexander, chief economist at Deloitte Canada, who has testified half a dozen times to Parliament's economic committees. "You are pulling forward the expectation, but it's still a long way out."