Tiff Macklem charts Bank of Canada’s path out of pandemic stimulus

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Bank of Canada Governor Tiff Macklem has begun the delicate work of extricating the central bank from the bond market.

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Macklem used a speech Thursday to chart an end to the Bank of Canada’s first use of quantitative easing, or QE, a relatively aggressive approach to keeping interest rates low that sees central banks use their unique ability to create money to purchase financial assets.

The Bank of Canada deployed QE to fight the COVID-19 recession, and so far as acquired more than $330 billion of Government of Canada debt since the end of March 2020. Central bankers dislike becoming active players in private markets, but without their intervention, the cost of borrowing money to invest probably would drift higher, slowing the recovery.

“As the recovery progresses, we are moving closer to a time when continuing to add stimulus through QE will no longer be necessary,” Macklem said in remarks prepared for an event hosted by Fédération des chambres de commerce du Québec. “We are not there yet,” he added. “That timing is a monetary policy decision that will depend on economic developments.”

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The recession that the pandemic triggered is over, but the recovery remains well short of Macklem’s goals. For example, the labour underutilization rate — an indicator that combines the jobless rate with the number of potential workers who aren’t looking for jobs and employed people who worked less than half their usual number of hours — was 14.4 per cent in July, down from 34.8 per cent in May 2020, but still higher than the 11.4-per-cent number recorded in February 2020.

Also, gross domestic product contracted at an annual rate of about one per cent in the second quarter, a decline that Macklem described as “more pronounced that we anticipated.” Indeed: Forecasters, including the Bank of Canada, had predicted an increase.

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The Bank of Canada expects “strong” growth over the second half of the year, but policy-makers nonetheless opted to leave the benchmark lending rate pinned near zero at the end of their latest round of policy deliberations on Sept. 8. They also said they would continue to purchase federal debt at a pace of about $2 billion per week. Bay Street economists and the bond traders they advise are now trying to figure out when policy-makers will taper that amount to zero.

Macklem offered no clues about when that will happen, but he did provide a path that should allow market participants lots of time to figure it out.

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The end of QE won’t mean the end of the Bank of Canada’s active participation at bond auctions. Macklem said the central bank will pivot to a “reinvestment phase” that will see the proceeds of maturing securities used to maintain the Bank of Canada’s portfolio at current levels. The governor said those purchases likely will average about $1 billion per week.

“When we arrive at the reinvestment phase, we will communicate this monetary policy decision clearly,” Macklem said. “When we get to the reinvestment phase and how long we are in it are monetary policy decisions that will depend on the strength of the recovery and the evolution of inflation.”

Prices represent the biggest wildcard. The consumer price index (CPI) increased 3.7 per cent in July from a year earlier, matching the biggest gain in a decade. Macklem reiterated that he thinks most of the upward pressure on inflation is the result of temporary factors related to the pandemic, but he conceded that he can’t be sure of that. The central bank’s target for inflation is two per cent, so it can’t tolerate price increases at current levels forever.

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That’s why some Bay Street analysts think policymakers could taper QE as early as next month. Macklem didn’t close the door on that possibility, emphasizing the reinvestment phase should also be seen as stimulus because it will be keeping an elevated amount of money in the financial system.

Macklem reiterated that he intends to leave the benchmark interest rate unchanged until the second half of next year, but he made clear that there was no link between the decision about when to raise the interest rate and when to reduce the size of the Bank of Canada’s crisis-era bond holdings.

“Eventually, the reinvestment phase will end, and we will stop purchasing bonds to replace the ones that are maturing,” Macklem said. “It is reasonable to expect that when we do eventually need to reduce monetary stimulus, our first move will be to raise the target for the overnight rate — our policy interest rate.”

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