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From the moment the Bank of Canada opened the door on quantitative easing two and a half weeks ago, speculation began about what it would, or should, push through it.

Should it increase the size of the program beyond its initial – some felt, modest – $5-billion-a week purchases of Canadian government bonds? Should it start targeting specific debt maturities, in order to, say, reduce longer-term interest rates rather than simply provide liquidity? Should the program expand to corporate bonds or even equities, to throw its weight behind the struggling business sector?

As the central bank prepares for Wednesday’s first policy update since launching its large-scale asset purchase (LSAP) program – a fairly mild version of QE, at least so far – there is growing consensus around what it should do for its encore: Add provincial bonds to the mix.

While other ideas hold merit, a compelling mix of market forces and politics could nudge the central bank in the direction of provincials.

Some observers see logic in the bank acting on Wednesday, when it issues its regularly scheduled update on its policy position as well as its quarterly economic outlook. Followed by a press conference, the update is a great opportunity to not only announce its next significant move, but publicly explain it.

The spread between yields on provincial bonds and Canadian government bonds – essentially, the interest rate premium that provinces pay investors for being considered higher risk than the federal government – has widened considerably since the COVID-19 crisis hit. That can be blamed partly on investors’ general flight from risk, but more specifically on the heavy supply of new provincial debt that the markets will have to absorb in the coming months. The situation is further complicated by heavy supplies coming on the market from governments around the world coping with their own suddenly elevated financing needs.

As provincial governments see it, the markets are turning against them at precisely the time that they have little choice but to issue considerably more debt – an adding-insult-to-injury sort of thing. They have been pressing Ottawa, in its current spirit of assisting the downtrodden, to come to their aid.

Some provinces, led by Manitoba Premier Brian Pallister, have been lobbying the federal government to launch an emergency program to borrow on their behalf – at its lower rates – and then lend the money to them at cost, thus passing the savings along. But a de facto federal guarantee of provincial debt is not something Ottawa relishes. Besides, as Bank of Canada Governor Stephen Poloz pointed out recently, with Canadian government 10-year bonds trading at about 0.75 per cent, borrowing is remarkably cheap for everyone right now – even the provinces, despite the elevated risk premiums.

If the real issue is the widened spreads – perhaps an early signal that the market for provincial debt is under undue pressure – a much better solution would be for the central bank to step in with purchases of provincial debt in the open market. This would facilitate smoother functioning, just as it is doing in the Canadian government debt market. As with the elevated federal debt supply that the market anticipates this year, purchases by the central bank would help keep the provincial market more in balance.

The result would help maintain efficient access to long-term debt for the provinces while assisting to keep a lid on interest rates – thus delivering the kind of help the provinces seek.

Of course, there’s a question as to whether this is more a political want than a legitimate market need at this point. The Bank of Canada’s primary focus in all its market measures during this crisis has been ensuring liquidity and smooth market functioning; widened spreads are not, in themselves, evidence of a malfunctioning market.

“You have to separate the political noise from what is, indeed, the actual need,” said Adam Hardi, vice-president and senior analyst at Moody’s credit rating agency. “We certainly haven’t seen evidence that the capital markets would be shutting out provinces.”

It’s not the Bank of Canada’s job to provide cover for the federal government against provincial leaders agitating for help; in normal times, the bank fiercely protects its independence from political interests. But these are far from normal times; we have seen Mr. Poloz share a podium with Finance Minister Bill Morneau at press conferences twice in the past month, a calculated public sign of how closely the government and the central bank are working together to navigate this mess. A provincial bond-purchase program, perhaps in tandem with federal government initiatives to aid the provinces, certainly isn’t out of the question.

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