The Bank of Canada has set a high bar for the eventual raising of interest rates. But that doesn’t mean the central bank is equally reluctant about scaling back its quantitative easing program, even if it’s not yet willing to say so out loud. They’re two separate and distinct questions.
In Wednesday’s policy announcement, the bank maintained that the economy still has a long and difficult road to full recovery from the COVID-19 recession, despite the clearly better-than-expected performance through the second wave of the pandemic. Significantly, the bank emphasized the damage to the labour market, taking pains to identify key groups (women, youth and low-wage workers) that have suffered more than others.
This was an important clarification on where the bank stands regarding raising its key interest rate from the current record low of 0.25 per cent, where it has stood since the bank made a series of rapid-fire cuts at the beginning of the pandemic.
The bank has committed since last July to hold the rate at this bottom “until economic slack is absorbed so that the [bank’s] 2-per-cent inflation target is sustainably achieved,” a pledge it repeated – again – in Wednesday’s statement.
Now, as the economy’s surprising resilience and the accelerating rollout of vaccines has raised hopes for a faster-than-expected recovery, the bank is making it clear that a closing of the output gap (the difference between what the economy produces and its full capacity) won’t be enough; the bank is looking for a closing of the labour gap, too. By expressing specific concern about the hardest-hit segments of the labour force, it is nudging the bar for full employment even higher.
The increased emphasis on labour slack – it was also the central theme of a speech by Bank of Canada Governor Tiff Macklem two weeks ago – may cool heels in the bond market, which has viewed the improving economy as evidence that the output gap might close sooner than previously thought, accelerating expectations of rate increases in the process.
Labour slack will almost certainly take longer for the recovering economy to sop up. The central bank wants the bond market to grasp that message in the latter’s zeal to pin down the rate outlook.
But the rate debate is all about what the world will look like a year or two from now. Officially, the bank is still talking about 2023 for the conditions being in place to start raising rates, although it kicked the door wide open to revise that when it updates its economic forecasts – certainly upward – in April.
The QE program – under which the bank buys $4-billion a week of Government of Canada bonds to try to tone down long-term interest rates – is tied much more to the here and now. The bank has pledged to continue the program only until the recovery is “well under way,” and has signalled that even before then it is ready to scale down the pace of purchases.
The better-than-expected economy implies “well under way” has moved closer. While it still may be many months away (and is quite intentionally open to subjective interpretation), many observers think scaling down purchases – “tapering,” as it’s often called – could begin as early as April.
Mr. Macklem clarified in a news conference last month that as long as the bank still makes “positive net purchases of Government of Canada bonds,” it considers it still has a QE program in place. So, it can reduce its weekly purchases well before reaching its “well under way” pledge, as long as the total amount of bonds it owns continues to rise, even as some holdings mature in the coming months and drop off its balance sheet.
Ian Pollick, global head of fixed income, currency and commodities strategy at CIBC Capital Markets, figures the central bank could cut its purchases in half and still remain net-positive in the program. That gives it scope for, say, a pair of tapers of $1-billion a week, before eventually exiting QE.
The improved economic outlook isn’t the only reason to think the Bank of Canada might do this sooner rather than later. The bank now owns nearly 40 per cent of the entire market for Government of Canada bonds; by Mr. Macklem’s own reckoning, 50 per cent is an approximate line at which its dominance could create undue distortions in the market. At the current pace of purchases, it still has a few months before that issue comes to a head, but clearly the runway is getting shorter.
It should be pointed out that the bank didn’t say much Wednesday that tipped its hand on the timing of tapering. Still, its clear acknowledgement of the much-improved economic landscape certainly sets that stage. The bank now has six more weeks to see if the recovery takes hold, as all indicators suggest it will, before an April retreat from QE that should by then look entirely appropriate – and entirely divorced from the still-distant interest rate question.
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