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Bank of Canada Governor Tiff Macklem in Toronto on Sept. 10, 2020.

Fred Lum/The Globe and Mail

The Bank of Canada will reduce its Canadian government bond purchases by 20 per cent while shifting toward longer-term bonds, as it recalibrates its quantitative easing to deliver stimulus to an economy that is headed into a slower and less certain phase of recovery.

In its monetary policy decision Wednesday, the central bank maintained its key interest rate at a record-low 0.25 per cent and reiterated its pledge to maintain this level “until economic slack is absorbed so that the 2-per-cent inflation target is sustainably achieved.” It said that, based on its latest economic projections, “this does not happen until into 2023” – the first time the bank has given an explicit timetable for when rates might come off their historic floor.

But it did decide to “gradually” scale back its purchases of Government of Canada bonds – the cornerstone of the bank’s other chief form of stimulus, its quantitative easing or QE program – to $4-billion a week from $5-billion, while changing the composition to focus on maturities in the three-year to 15-year range, “which have more direct influence on the borrowing rates that are most important for households and businesses.” The bank asserted that this will provide “at least as much monetary stimulus as before” despite the program’s reduced size.

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The bank made the change as it issued a more cautious outlook for the economy after the stronger-than-expected rebound from the COVID-19 lockdowns, warning that the lingering effects of the pandemic will weigh on economic growth potential for years.

“The very rapid growth of the reopening phase is now over, and we are in the slower-growth recuperation phase,” BoC Governor Tiff Macklem said in his opening remarks to a news conference Wednesday.

In its quarterly Monetary Policy Report, the bank said it doesn’t expect the Canadian economy to return to full capacity “until 2023,” cautioning that business investment will remain subdued, exports will continue to recover only gradually and the housing market will moderate after its strong rebound in recent months. It sees inflation remaining well below its 2-per-cent target through 2022.

The bank said the pandemic has put a deep dent in Canadian and global economic potential – which implies that the economy’s ability to grow will be hampered over the next several years.

“Persistent scarring effects of the pandemic on the labour force, investment and the structure of the economy will lower potential output growth considerably,” it said.

The bank projected that Canada’s economy will contract by 5.7 per cent this year – in line with the forecasts of most private-sector economists, and a substantial upgrade from its forecast in July of a 7.8-per-cent plunge. The improvement reflects the economy’s surprisingly rapid rebound as COVID-19 containment measures were lifted over the summer.

However, the bank warned that the reimposition of some restrictions because of the recent surge in COVID-19 infections will dampen the fourth quarter, predicting only “very modest” growth of 0.2 per cent quarter-over-quarter (1 per cent annualized). It lowered its 2021 growth projection to 4.2 per cent from 5.1 per cent.

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The BoC’s news conference ended just minutes before federal Finance Minister Chrystia Freeland delivered a speech laying out the case for continued aggressive government spending in support of the economic recovery. She argued, in part, that with the central bank already at near-zero interest rates, “monetary policy is running out of bullets. That puts the onus squarely on fiscal policy to grow our way out of this recession.”

Mr. Macklem told reporters that by convention, the bank’s economic forecasts only incorporate government policies that have already been announced. Nevertheless, Bank of Nova Scotia economist Derek Holt suggested that the central bank’s largely stand-pat policy stance may be influenced by an expectation that the government’s coming fall mini-budget will keep the foot firmly on the spending gas pedal.

“The BoC is not operating in a policy vacuum,” Mr. Holt said in a research report.

There had been growing speculation in recent weeks about when the BoC might start scaling down its QE program, given that it has achieved its initial goal of financial-market stability and is imposing an increasingly large footprint on the market. As a result of the purchases, the bank now holds roughly 35 per cent of all outstanding Government of Canada bonds, up from 13 per cent before the program launched in April – raising concerns that its big role might lead to market distortions.

But Mr. Macklem indicated that reducing the bank’s large position was not a key motivation behind the decision to reduce its purchases.

“This adjustment is about maximizing the effectiveness of the program,” he said. “We can buy less, because we’re increasing the impact per dollar, and still have at least as much monetary stimulus as we had before.”

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“I would underline that there is scope to do more if we need to do more,” he said.

But Mr. Macklem signalled that there’s little scope to going further on the interest-rate front. He once again shot down the notion of taking the bank’s key rate into negative territory, as the European Central Bank has done.

“In the current situation, it’s not something that we think would be very helpful – in fact, could be disruptive,” he said.

Mr. Macklem’s comments should cool speculation about negative rates that he had fuelled this month, when he used the phrase “never say never” when discussing his position after a speech.

“It is in the tool kit, and if the situation were to dramatically change, it is something we could consider. That’s what I meant by ‘never say never.’ The bar would be very high to do that,” he said. “It is not something that we are currently discussing, it is not something we discussed at our most recent policy deliberations.”

The bank said its economic outlook remains “highly conditional on the course of the virus and the measures needed to contain it.” Its projections assume that another round of “extensive lockdown measures” similar to last spring’s economic closings aren’t necessary, although more localized and targeted restrictions will be. It also assumes that COVID-19 vaccines will be “widely available” by mid-2022, “at which time the direct effects of the pandemic on economic activity will have ended.”

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