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MNI INTERVIEW: BOC Seen Having Smooth Shift From Taper to Hike

MNI (Ottawa)
OTTAWA (MNI)

Former researcher Mendes sees QE wrap-up in October, more risk around timing of hike next year.

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The Bank of Canada will have a smooth transition out of asset purchases later this year while facing more risks around the timing of an interest-rate rise in 2022, former central bank researcher and CIBC Senior Economist Royce Mendes told MNI.

Governor Tiff Macklem will likely taper government bond buying again in October to CAD1 billion a week from the current CAD2 billion, a pace that will simply match maturing assets and may even lead the BOC to drop the QE label, he said. Asset purchases began last year at CAD5 billion and shifting to a net neutral stance would be far ahead of the Fed and ECB, though other peers in the U.K. and New Zealand are also looking to scale back.

Macklem has said he will further adjust QE if the strong economic rebound comes through in the second half of this year. The governor has declined to detail any preferred sequence from tapering to a rate hike he says could come in the second half of next year if the economy returns to full potential and inflation returns to the 2% target. The BOC's guidance to date suggests the decisions to curtail QE and to hike rates to 0.25% are on separate tracks, Mendes said.

"No matter when QE ends, if it ended tomorrow, they have still committed to keep rates on hold," he said. "When QE ends, it has no bearing on when the first rate hike is coming, it's really going to be conditional on reaching the established goals for the economy."

Mendes' analysis with CIBC's global head of fixed income Ian Pollick suggests the CAD1 billion pace will match up with maturing government assets next year. They say QE could be simple to unwind because the policy had a modest impact on the government bond market, lowering 10-year yields by about 15bps.

TANTRUM-FREE TAPER

"We don't think QE did a whole lot in Canada and we don't think there's really a possibility of a taper tantrum as this winds down," said Mendes, who at the BOC was a foreign reserve portfolio manager and principal researcher in the financial markets branch.

Other experts see the BOC as more obliged to clearly shut down QE before it entertains a rate increase, though in practice they agree the central bank is facing pressures to wrap up bond buying. (See MNI INTERVIEW:BOC to End Active QE Before Rate Hike-Ex-Adviser)

Asset purchases have caused strains in debt markets as BOC purchases moved over 40% of the stock of federal bonds, Pollick said, including reduced liquidity and distorted pricing.

"If you just think about the amount of bonds that have been removed from various sectors of the curve, at the end of the day it's almost like you're purposely unplugging your phone. Because the bond market is the first responder in terms of what it's trying to signal to you" on things like inflation pressures, he said.

Trading in BAX contracts that recently showed a potential rate hike around March are also a "mirage" triggered by distortions linked to trading during the pandemic and pressures on hedging during a housing boom, Pollick said.

The path to the first rate increase since 2018 remains within the BOC's guidance for the second half of next year, Mendes said. The BOC's recent upgrade to its view of a consumer spending spree as the economy re-opens may underestimate the rebound's speed, while new Covid-19 variants could delay the comeback. "The base case remains somewhere in the middle," he said.