Rpt- MNI INTERVIEW: BOC Losses May Dent Inflation Fight- Tombe

The Bank of Canada will lose up to CAD8.8 billion on its QE bond purchase program over the next three years, an unprecedented situation that may undermine its message to the public about bringing inflation back to target, the author of a new study on the issue told MNI on Wednesday.

“Financial losses might be seen as a sign of poor management; we don’t think that is the case,” said Trevor Tombe, who co-authored the paper due out Thursday from the C.D. Howe Institute, which runs a shadow monetary council.

“That matters a lot because the confidence that the public has in the central bank affects how strongly our inflation expectations will be tied to Bank policy objectives. And if our objectives our very strongly aligned with the central bank policy of 2%, then it’s easier for the Bank to achieve the target,” he said.

Tombe is a University of Calgary professor who does research with central bank staff and advises federal and provincial governments. He co-authored the paper with Calgary colleague Yu (Sonja) Chen, estimating losses of at least CAD3.6 billion depending on interest rates and future balance-sheet management. The most likely loss is CAD5.7 billion, a figure in line with some past reports.

DEFERRED ASSET SOLUTION

The Bank has never posted an annual loss since its beginnings in the Great Depression of the 1930s, and before the Covid pandemic often sent at least a billion dollars a year of profits to the federal government. There is no clear legal rule for booking losses in an era where the interest paid out on deposits at the central bank is less than interest earned on the bonds it purchased.

It's surprising the government has waited half a year without giving some guidance or making a legal amendment, though it may be coming in a budget due this spring, Tombe said. The best option is mirroring the Fed's system of creating a "deferred asset" covering today's losses out of future expected profits, he said.

One obstacle for the Liberals is the Conservative leader's call to fire Governor Tiff Macklem for what he says amounts to "printing money" to pay for "reckless" budget deficits. McGill University professor and former BOC and government adviser Chris Ragan said Tuesday at a seminar that negative views around losses are “optics more than substance, but it’s nonetheless there.”

Tombe said “we’ve seen these concerns being raised in lots of countries” and “these losses may be used politically as a way to potentially undermine public confidence in the Bank.”

HOLDING AT PEAK RATE

The debate about whether the Bank went too far with QE is worthwhile to continue, Tombe said, adding that “I don’t think that right now we’re in a case where we need more oversight” of the Bank by the government. (See: MNI INTERVIEW: BOC Needs More Scrutiny Amid QE-Conservative MP)

The paper assumes the 4.25% policy rate will rise to 4.5% at the Jan. 25 meeting and remain there for about a year, declining to 3% within three years. Macklem has said he's resolute in making sure inflation returns to 2% from about 7% today, a goal that may not be reached until the end of 2024.

Tombe's own view is there's some evidence inflation is easing but policy makers will make sure inflation doesn't become entrenched. “They are erring on the side of ensuring that these price pressures don’t continue. I think that’s the right balance."