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Ex-advisor Morck says fragile mortgage market means BOC going slow on balance-sheet unwind.
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The Bank of Canada's balance sheet will remain elevated beyond the time benchmark rates rise to 2% or more, despite an early end to the current round of quantitative easing, former central bank research fellow Randall Morck told MNI.
Inflation pressures will justify higher rates ahead, Morck said, assuming the economy regains momentum following the pandemic and fiscal policy remains stimulative. However, greater caution is needed unwinding the balance sheet as lending markets remain fragile in an era where commercial banks have been allowed to overlook nonperforming mortgages, he said.
"It may be that we just have to get used to the balance sheet being bigger, and that implies perhaps accepting a bit of inflation for a while, because shrinking the balance sheet can be macroeconomically very damaging," said Morck, who teaches at the University of Alberta.
"I'm more worried about bank stability going forward, governments are able to back down from some of their deficit spending," said Morck, adding there are signs commercial banks are carrying a lot of underperforming mortgages.
Boosted by Canada's first full-scale use of quantitative easing, aimed at tackling the biggest economic downturn since the 1930s, the BOC's balance sheet swelled to a record CAD575 billion in March, up from CAD125 billion pre-pandemic, but has since fallen back from the highs.
Morck's believes the central bank could find it difficult to get out of emergency balance sheet policies now, with interest rates a better tool to target higher than wanted inflation once net new bond purchases end.
Tightening to fight inflation is certainly a clear goal, he said, although noting it was still unclear whether higher prices were transitory or not. But central banks shouldn't force any tightening based on the oft heard argument about having enough firepower to deal with the next downturn, Morck added.
"This idea that we really have to give central banks scope for lowering interest rates, I'm just not sure it's really that important," he said.