Bank of Canada signals exit from stimulus

The Bank of Canada (BoC) took the biggest step yet by a major economy to reduce emergency levels of monetary stimulus as it hailed a stronger-than-expected recovery from the pandemic.

Policy makers led by Governor Tiff Macklem said they would scale back their purchases of government debt by a quarter to C$3 billion ($2.4 billion) and accelerate the timetable for a possible interest-rate increase.

The upbeat turn toward plotting a return to more normal policy has been resisted by counterparts elsewhere, including the U.S. Federal Reserve. Investors reacted by driving the Canadian dollar to its biggest gain since June.

"This is a fairly hawkish message cast by the Bank of Canada," Simon Harvey, a senior foreign exchange analyst at Monex Canada, said by email. "They seem quite confident that once the current wave of infections subsides the economic recovery will be robust."

The central bank reiterated its guidance that it won't raise its benchmark interest rate, currently at 0.25%, until the recovery is complete and inflation is sustainably at 2%. But it changed its projections on when that would happen.

In new quarterly economic projections, it revised higher its growth estimate for 2021 by more than two percentage points, to 6.5%, and brought forward its forecasts for when slack would be absorbed. "Based on the Bank's latest projection, this is now expected to happen some time in the second half of 2022," the bank said in its latest Monetary Policy Report.

At a subsequent press conference, Macklem emphasized that the central bank's commitment is not to raise interest rates before the economy fully recovers, and that any future hike would reflect economic conditions at the time.

The Federal Reserve, by contrast, says it won't begin scaling back the pace of its $120 billion-a-month bond purchases until it sees "substantial further progress" on employment and inflation. Economists surveyed by Bloomberg ahead of the Fed's March meeting didn't expect that to happen until 2022.

Macklem's growth revisions bring policy makers more into line with economist projections. Markets had already been pricing in a rate increase in 2022 before changes. Investors have also been anticipating that Canada's central bank would be more aggressive than the Federal Reserve in its normalization path.

Swaps trading suggests about a 50% chance of a hike in Canada this time next year. Almost three hikes are fully priced in over the next two years, and five hikes over the next three years.

Chair Jerome Powell, for his part, has been careful to avoid putting a date on beginning to taper asset purchases in the U.S., though his No. 2, Vice Chair Richard Clarida, has said he doesn't expect those thresholds to be met this year.

Powell has promised to give investors plenty of warning that officials are beginning to debate the timing of a move. He's been up front in wanting to avoid surprising markets and re-running the 2013 Taper Tantrum, when unexpected news that the Fed was thinking of paring its purchases sent financial markets into a spasm with harmful economic consequences.

Loonie Soars

The Canadian dollar rose 0.9% to C$1.2495 per dollar at 3:47 p.m. in New York, after gaining as much as 1.2%. The market consensus was for the Bank of Canada to pare back its government bond purchases in line with the bank's new guidance, without altering expectations for no rate hike before 2023.