MNI STATE OF PLAY: BOC Set to Limit QE to Steady Balance Sheet

Bank of Canada Governor Tiff Macklem said Wednesday his growing confidence in a durable economic rebound means there will likely be less need for asset purchases in the future, and the next move for policymakers is towards a phase that stabilizes the size of the central bank's balance sheet.

"If that plays out," on a strong economic rebound, "there will be future adjustments," Macklem said in response to a question from MNI at a press conference Wednesday. Earlier the BOC slowed QE to CAD2 billion a week from CAD3 billion, and affirmed the conditions to raise interest rates from their record low 0.25% should emerge in the second half of 2022.

"As we adjust QE down further, we will eventually reach a point where our gross purchases will be roughly equal to the maturities," he said. That would still leave a large balance sheet without adding new stimulus, Macklem said.

The Governor wouldn't say if asset purchases will end before interest rates rise, a debate that has emerged in other countries where central banks are moving ahead with QE amid rising inflation. The BOC's holdings of federal government bonds climbed to 44% of total issuance, a stockpile that, as it grew, as led to investor complaints about possible trading frictions.

THIRD ROUND OF TAPERING

The BOC's third taper from the original CAD5 billion pace underlines the economy's recovery, with Macklem telling reporters there was a "strong consensus" among bank officials about the rebound's strength.

Comments about re-investing proceeds of maturing debt are in line with a March speech by Deputy Governor Toni Gravelle laying out the idea of stabilizing the balance sheet. Total assets have already shrunk with the repos and treasury bills the BOC bought last year to fight a trading squeeze rolling off the books.

Source: BOC

The BOC's stockpile of bonds is nearing the point where maturing assets will become a bigger influence over the size of the balance sheet, the BOC suggested in its Monetary Policy Report, without elaborating. It's unclear what pace of QE would be needed to hold the value of a balance sheet that has shrunk to CAD485 billion from a peak of CAD575 billion in March. Before the pandemic, the balance sheet was just CAD120 billion, thanks to Canada avoiding QE purchases in the 2008 global financial crisis.

Former BOC Governor David Dodge told MNI in April that Macklem would keep tapering to avoid distorting fixed-income markets. Other former officials had told MNI the pace of the rebound justified moves like today's and a path to ending QE, or at least net new purchases, later this year.

SETTING RATE-HIKE STAGE

Today analysts at Bank of Montreal, Desjardins and ING said QE will largely wind down around the end of this year. Shrinking QE also solidifies predictions the BOC will meet its guidance of a rate hike in the second half of next year, if not a little sooner. Trading in BAX contracts suggests a 61% chance an increase could come by next March.

"We expect the tapering process to continue apace, with the Bank winding down its QE by early next year. This will set the stage for rate hikes," Bank of Montreal chief economist Doug Porter wrote in a research note. "While the perception is that the Bank is quite hawkish, especially compared with the Fed, we ultimately expect very little daylight between the two banks when it comes to rate hike timing," given the depths of Canada's pandemic slump, he said.

Governor Macklem also said changes to asset purchases would be gradual and stressed it depends on the recovery coming along about as the BOC projected. Earlier in the pandemic the BOC had said it would maintain QE until the economic recovery was well underway, and Gravelle in March said reinvesting assets would be "easing our foot off the accelerator, not hitting the brakes."

Macklem also told reporters that removing stimulus will be conditioned by the BOC's single mandate to reach 2% inflation, even as he's watching for a broad job recovery. "We have one target, and that's inflation," he said.