Bank of Canada might cut bond buying and hint on future rate hikes

It looks like the central bank is ready to start reducing its asset purchases amid a better and faster than expected economic recovery. It could be one of the largest steps from a developed country aimed at cutting its level of monetary stimulus.

On Wednesday, Governor Tiff Macklem is expected to reduce the Bank of Canada’s weekly government bond purchases from $4 to $3 billion. In addition to it, we may hear certain hints on whether a new timeline for interest rate increases is coming. Now, the BoC points to no changes until 2023.

Tomorrow’s decision will be crucial for the Bank. Its quantitative easing program is too massive for the size of Canada’s bond market, so it needs to be reduced as the government’s financing requirements are going down.

Moreover, we can see new reasons for reducing the stimulus. Canada’s economy is showing a much faster pace of recovery than the Bank has been expecting, and officials have to get ready for the policy normalization.

“The economic outlook has improved significantly since January”, – Dominique Lapointe, an economist at Laurentian Bank Securities Inc., noted. “The central bank is ready to reduce the stimulus”.

The Bank is not eager to outpace other major central banks, for instance, the Federal Reserve, which has been very careful with talks on paring back. If the BoC starts acting first, it may lead to currency growth and, thus, to undesirable consequences.

It should be noted that the Bank’s asset purchases have been more massive than in case of other Group of Seven members – at least compared to the size of the nation’s bond market.

The BoC has bought almost $280 billion in Canadian government bonds during the previous year, increasing its balance sheet to about one-quarter of economic output. Today, it has more than 40% of outstanding bonds and is on its way to exceeding 50%.

It’s a huge presence threatening to cause financial distortions. This is exactly why Macklem decided to decrease the minimum weekly purchases in October from the previous $5 billion.

Meanwhile, the Bank will definitely not change its key lending rate. Economists unanimously expect the rate to remain unchanged at 0.25% this time. Moreover, the Bank has promised not to raise it until all economic damages are fully offset, so that inflation could get back to the 2% target level. And no one knows when it will happen.

In its January economic forecast, the Bank noted it may happen in 2023 or later.