Bank of Canada starts reducing its economic stimulus

Canada’s central bank took the first and the strongest step by a developed economy to reduce the level of its monetary stimulus, supported by a faster-than-expected economic recovery from the pandemic.

On Wednesday, the Bank of Canada Governor Tiff Macklem noted they would reduce their purchases of government debt by a quarter to $3 billion (US$2.4 billion). In addition to it, the BoC accelerated the timeline for a possible interest rate hike.

Meanwhile, other central banks decided not to change the tone towards a faster return to more normal policy, including the U.S. Federal Reserve. Investors reacted by raising the Canadian dollar to its highest level since January.

“It’s quite an aggressive message from the BoC,” – noted Simon Harvey from Monex Canada. “They are quite sure that as soon as today’s wave of infections goes down, the economic recovery will be strong.”

The BoC reiterated its promise not to raise its key lending rate until the recovery is complete and inflation is strongly at 2%. Nevertheless, it changed its forecast on when it could happen.

The new quarterly economic forecast shows the Bank has revised its growth estimate for 2021 by more than 2% to 6.5%.

“Based on the Bank’s recent expectations, the moment when the economic slack is fully absorbed is now expected during the second half of 2022,” – the report noted.

Macklem underlined that Bank’s promise not to raise interest rates before the economy fully recovers, and noted that all future rises will reflect the current economic conditions.

Meanwhile, the Federal Reserve, doesn’t plan to reduce its US$120 billion-a-month bond purchases program until it sees significant progress in the sectors of employment and inflation. Economists polled by Bloomberg before the Fed’s March meeting didn’t predict it until 2022.

Macklem’s new growth forecasts are in line with economist expectations. Markets have already been pricing in a rate hike in 2022 before such changes. Investors have also been expecting the BoC to be more aggressive than the Federal Reserve.

In case of swaps trading, we can see forecasts of a 50% odds of a rise in Canada in a year from now. About three increases are expected during the next two years, and five rise may happen during the next three years.

At the same time, the government is still quite careful in spite of a more positive tone, saying there’s more uncertainty than usual which could influence its forecasts for slack. The government also highlighted worries concerning the uneven rebound and the potential for problems in the labor market.