Why BOC is open to cutting rates
Scenario becomes point of contention for some on Bay Street, Kevin Carmichael says.
The Bank of Canada has now officially said it could potentially drop the benchmark interest rate below its current setting of 0.25 per cent, while emphasizing that it remains deeply skeptical of negative interest rates.
That might not sound like a big deal, but it's been a point of contention in some Bloomberg chat boxes on Bay Street since governor Tiff Macklem flicked at the possibility of a lower policy rate during parliamentary testimony last month.
The Bank of Canada still sees 0.25 per cent as the “effective lower bound” for interest rates. Central bankers reckon that anything lower would likely cause more problems in financial markets than could be justified by the stimulus that would result from a lower setting.
But Macklem and his deputies have opted to give themselves some wiggle room, probably because other central banks, including the Reserve Bank of Australia, have recently tested what they thought were their interest-rate floors without causing any obvious harm.
“Should things take a more persistent turn for the worse, we have a range of options at our disposal to provide additional monetary stimulus,” Paul Beaudry, a deputy governor, said in a speech on Thursday. Those options include creating more money to purchase bonds, or targeting specific types of debt for purchase in hopes of lowering particular borrowing rates. “It could also include reassessing the effective lower bound, which would allow for the possibility of a lower — but still positive — policy rate,” he said.
To be sure, the Bank of Canada isn't predicting economic conditions will get worse. Policy-makers on Wednesday indicated they were open to rethinking things by emphasizing that their current judgment is based on how the world looked in October, when Canada was on the verge of a second wave of COVID-19 infections and restrictions. By January, when the central bank next updates its outlook, a vaccination program could be in full swing.
But for now, the central bank is playing it safe by opting this week to leave interest rates and its bond-buying strategies unchanged.
Citigroup Global Markets Inc.'s Veronica Clark called the new policy statement “decidedly neutral,” a take that Beaudry reinforced in his speech.
“Going forward, both downside and upside risks to inflation are in play,” he said. “That means being prepared to respond in either direction. Thankfully, we have the tools to do so.”
There's nothing neutral, however, about the Bank of Canada's position on negative interest rates. Until a decade ago, few thought it was even possible to drop borrowing costs below zero. But many European central banks have now done so as part of their desperate struggle to stoke economic growth and boost inflation. The idea is no longer considered crazy.
Still, former Bank of Canada governor Stephen Poloz was never keen, and Macklem endorsed that stance as soon as he took over. Beaudry went out of his way to make sure no one on Bay Street confused a softening of the effective lower bound with renewed interest in a benchmark rate below zero.
“In theory, negative interest rates remain in the bank's tool kit,” he said. “But we've been clear that, barring a dramatically different set of circumstances, we don't think negative rates would be productive in a Canadian context.”
Policy-makers probably won't have to make that call, at least during this crisis, according to Simon Deeley, a rates strategist at RBC Dominion Securities Inc.
Investment banks such as RBC Dominion have more incentive to take risks than central bankers, who have a lot more riding on mistakes than the size of their Christmas bonuses.
Deeley is already advising his clients to assume the Bank of Canada will adopt a more optimistic outlook next month, which would, in turn, prompt policy-makers to start thinking about tapering the bond purchases at the core of a policy strategy called quantitative easing (QE).
“Given our view of a stronger medium-term outlook and fiscal authorities supporting the economy through to a vaccine, we think the discussion on the QE unwind is much more relevant going forward,” Deeley said in a note to clients.
Central bankers still remember the “taper tantrum” that occurred in 2013 when Ben Bernanke, the former chair of the U.S. Federal Reserve, talked about unwinding QE before investors were ready.
There should be no such surprise when the Bank of Canada gets around to tapering. Beaudry used his speech to describe how the bank might go about reducing stimulus when the time comes. The first step would be to simply slow purchases of government debt from the current pace of about $4 billion per week.
Then it would depend. The Bank of Canada could maintain a certain level of stimulus by using the proceeds of expiring bonds to buy new ones. If it's a little worried about inflation, it could keep those proceeds. The third option would be to actively sell the assets, which would probably only be necessary if policy-makers were seriously worried about inflation.
“What we do know today is that Canada's economic recovery will continue to require extraordinary monetary policy support,” Beaudry said.
We've been clear that, barring a dramatically different set of circumstances, we don't think negative rates would be productive ....