MNI INTERVIEW: BOC Needs Asset Sales to Check Inflation-Parkin

The Bank of Canada will need to sell some longer-term bonds in addition to allowing a natural run-off of maturing securities in order to reduce the size of its balance sheet and bolster the inflation fight, Michael Parkin, researcher at the CD Howe Institute that runs a shadow monetary council, told MNI.

While the Bank has about CAD200 billion of assets that mature in less than three years that it can allow to roll off naturally, that leaves another CAD225 billion of longer-term government bonds, most of which come due more than five years from now, Parkin said in an interview. Keeping hold of that longer-term debt would maintain monetary stimulus far longer than desirable, he said.

"The Bank's CAD500 billion balance sheet needs to return to its CAD125 billion pre-pandemic level to reinforce the Bank’s commitment to its inflation target," he said. "Selling CAD500 million a day will take three years to return to normal …you can do the math!"

The view expressed by Parkin contrasts with that of current Governor Tiff Macklem, who says he is not considering outright sales. The Governor on Thursday said that whenever roll-off starts the balance sheet could shrink "relatively quickly" with 40% of assets maturing within two years, but that for the moment the proceeds of maturing securities will continue to be reinvested.

BALANCE SHEET BACKSEAT

Parkin, once a thesis adviser to former BOC chief Stephen Poloz, isn't alone in showing discomfort with the Bank’s balance sheet. Conservative lawmakers at a hearing Thursday pressed the Governor on the idea that QE was a move to "underwrite" government deficits and feeds inflation. Early in the QE program some bond dealers also worried the Bank would own half the stock of federal bonds, hampering trading.

Macklem mostly inherited QE from Poloz, who brought it in to stabilize markets in the "dash for cash" that frayed debt markets early in the pandemic before it was expanded to offer more general economic stimulus.

The Bank wants the overnight rate to be the prime focus of monetary tightening and raised borrowing costs for the first time in three years Wednesday to 0.5% from a record low 0.25%. Macklem, who has cited the risk of price expectations getting out of hand, said Thursday he could hike 50bps if needed.

HIKE AT EVERY MEETING

Inflation, already around 5%, will likely exceed that level throughout the year and a jump in expectations would mean that "only a recession” could bring it back to the Bank’s 2% target, Parkin said.

The Bank should embrace "gentle quantitative tightening," to show its resolve, he said. "The Ukraine War might boost global inflation, but if the Bank demonstrates its commitment to returning inflation to its 2% target, Canadian inflation expectations will not creep up."

While the rate increase and the signal of more to come are helpful, "increases of 25 basis points at each of the next six meetings is the slowest that I would be comfortable with," he said. That would be a move at every meeting remaining this year, in line with some of the more aggressive market bets and ahead of almost all economists.

"The Bank must raise interest rates to a level that exceeds the expected inflation rate. If the Bank does not take this action, inflation expectations will eventually get out of hand," Parkin said.