E-Sight October 27: Bank of Canada ends quantitative easing helping to anchor inflation expectations

In a keenly awaited policy statement, the Bank of Canada announced that while it was leaving the overnight rate unchanged at 0.50% it was ending its quantitative easing program.  The bond buying will continue, but only reinvesting maturing bonds. The Bank’s decision reflects its expectations for continued strong economic growth, but can also be interpreted as a response to the recent acceleration in inflation.

The Bank released its updated forecasts, with expectations that the economy will grow 5% in 2021, 4.25% in 2022 and 3.75% in 2023. Supply disruptions – including shortages of inputs, bottlenecks and labour shortages – have temporarily reduced the economy’s potential pace of growth. This means that the slack in the economy will be absorbed more quickly, which has implications for the inflation outlook. 

The Bank of Canada said that it expects inflation to remain elevated into next year, but it should moderate to the 2% inflation target by late 2022. This expectation is consistent with the central bank’s view that the economic slack will be eliminate in the middle of next year – a couple of quarters sooner than in their last forecast. 

The end of the quantitative easing program may have been a bit sooner than investors anticipated, but it isn’t really surprising given that winding down the program was expected sometime this year. 

The decision to reduce stimulus should also be a strong signal to financial markets that the Bank is committed to price stability over the medium term. Critically, this should keep inflation expectations anchored. Governor Macklem also sent a strong message, “The Bank of Canada is committed to ensuring that price increases we’re experiencing today don’t become ongoing inflation…As these forces play out, it is our job to bring inflation back to target, and I can assure you we will do that.” 

As I have argued in many commentaries, central banks around the world are likely going to need to rebalance monetary policy sooner than they have been signaling. And, this is proving true in Canada. Beyond the end of quantitative easing, I believe that the overnight rate will need to be lifted by 75 to 100 basis points in 2022, with the first hike likely coming in the spring.  Well before the prior forward guidance from the monetary authority.

Categories: Bank of Canada, Canadian Economic Outlook, Canadian Inflation, E-Sight, Economics

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