The Bank of Canada entered the world of quantitative easing on Wednesday, making the first of many billion-dollar purchases under its recently announced government-bond-buying program that could double the central bank’s balance sheet over the coming months.
Even with the dramatic escalation of the fight against the COVID-19 economic crisis, experts say the bank still has room to manoeuvre to aid the ailing economy and misfiring credit markets.
Last Friday’s decision to cut the bank’s benchmark interest rate to a record-tying low of 0.25 per cent was widely anticipated. What has drawn more attention was the bank’s announcement of what it calls large-scale asset purchases – known more commonly in central banking circles as quantitative easing. Under the program, it will buy at least $5-billion a week of Canadian government bonds in the open market, injecting substantial amounts of liquidity into the financial system in the process. The program kicked off Wednesday with total purchases of $1-billion of five-year notes.
Experts estimate that by the time the year is out, the program could add $200-billion to the central bank’s balance sheet. Combined with other measures the bank has taken since mid-March to stabilize credit markets and inject liquidity – which, Bank of Canada Governor Stephen Poloz said last week, have already added about $90-billion – the balance sheet could end 2020 nearly quadruple the size that it started the year, around $400-billion.
And the program now looks to be the place where the Bank of Canada can take further steps, should economic and market conditions need it – now that it has tapped out on rate cuts.
Theoretically, the Bank of Canada could lower its key interest rate further. They have been taken into negative territory in other jurisdictions, most notably by the European Central Bank, and the Bank of Canada’s own research has estimated that the true lower limit for Canadian rates is likely about negative-0.5 per cent. But Bank of Canada Governor Stephen Poloz was clear last Friday, in announcing the rate cut to 0.25 per cent, that he considers that to be the practical bottom. Going negative, he said, could further destabilize the already shaken financial sector.
“The negative effects for the financial system [of negative rates] are pretty significant,” Mr. Poloz said in a news conference Friday. "At this stage, it would be not sensible to think of interest rates going lower than this.”
On the other hand, what struck many market watchers about the Bank of Canada’s bond-purchase program is that $5-billion a week is the minimum – there is no maximum. The central bank has already hinted that it is willing to expand the program if necessary.
“Those things can be done in very, very large amounts – I mean, literally unlimited. On those tools, we have as much room to manoeuvre as you would like,” Mr. Poloz said Friday.
“I think they are looking at this as a really open-ended thing,” said monetary policy expert Steve Ambler, a professor of economics at the Université du Québec à Montreal.
In addition to increasing the size of the bond program, central bank experts have suggested that the Bank of Canada’s next potential steps could include expanding QE to include other types of assets, such as provincial bonds or even corporate bonds. Carolyn Wilkins, Mr. Poloz’s second-in-command, acknowledged that corporate purchases, known as “credit easing,” is something the central bank considers one of the options in its monetary policy “tool kit.”
“The utility of doing that would be to affect the cost of capital that firms might be facing, and also help market functioning so that they can continue to issue and continue to have the working capital they need,” she said in Friday’s news conference.
Another possible tool, Ms. Wilkins said, would be what’s known as funding-for-lending, similar to a program that the Bank of England set up in 2012. Under such a scheme, the central bank provides subsidized funds to financial institutions on the condition that those banks use the money for loans to businesses.
“The idea is to build us a bridge to normalcy. Although, of course, there’s uncertainty [over] how long that would be, we are all hoping that it’s not very long. Say, three months, four months – that would be welcome if it works out that way,” Mr. Poloz said. “The financing we’ve put in place has that as a vision.”
The bank has pledged that it will continue the program “until the economic recovery is well under way.” Most economists still anticipate a bounce-back in the third quarter, on the assumption that COVID-19-related restrictions are eased by then – which aligns with Mr. Poloz’s suggestion of three or four months. But given the lag before economic indicators are published, it could be at least five or six months before the Bank of Canada will see the evidence of such a rebound. If the central bank waits to confirm the recovery is in place, the bond program could run to the end of the year.
Under that scenario, the bank’s balance sheet could swell to about $400-billion – equivalent to about 17 per cent of Canada’s gross domestic product.
Still, the Bank of Canada had a relatively small balance sheet going into this crisis that affords it ample room to expand, said Ian Pollick, global head of fixed income, currency and commodity strategy at CIBC Capital Markets. Prior to its COVID-19 actions, the Bank’s balance sheet stood at about 6 per cent of GDP, compared with nearly 22 per cent at the U.S. Federal Reserve. The Reserve Bank of Australia, which often gets compared with Canada due to having similar economies, entered the crisis with a balance sheet of about 9 per cent of GDP.
"On a relative basis to our partners around the world, we still have room,” he said.
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