Canada's Quantitative Easing Ends Early... Base Interest Rate Hike Expected to Accelerate

"Market Expectations Missed as 'Reduced to 1 Billion Canadian Dollars'... 'Inflationary Pressure Expected to Persist Longer Than Anticipated'"

Tiff Macklem, Governor of the Bank of Canada
[Photo by Reuters Yonhap News]

[Asia Economy Reporter Park Byung-hee] The Bank of Canada abruptly decided to end quantitative easing early at its monetary policy meeting on the 27th (local time), raising expectations that the timing of interest rate hikes will be accelerated. The Bank of Canada raised its inflation forecast for next year from 2.4% to 3.4%, expressing concerns about prolonged inflation.

Bloomberg reported that the Bank of Canada declared the end of its policy of purchasing assets worth 2 billion Canadian dollars weekly at the monetary policy meeting that day. Tiff Macklem, Governor of the Bank of Canada, said at a press conference after the meeting, "The economy is close to a full recovery," and "Quantitative easing is no longer necessary." Accordingly, the Bank of Canada is expected to purchase government bonds only to replace maturing bonds monthly, without increasing the overall bond holdings. Since the COVID-19 pandemic, the Bank of Canada has increased its bond holdings by about 350 billion Canadian dollars.

The early end to quantitative easing was a decision that surprised the market. Dominic Burning, foreign exchange investment strategist at HSBC, said, "The market expected the central bank to reduce asset purchases to 1 billion Canadian dollars."

The reason for deciding to end quantitative easing early is the risk of rising inflation. The central bank stated, "Supply chain disruptions and rising energy prices, which increase inflationary pressures, are expected to be stronger and more persistent than anticipated."

The Bank of Canada forecasted this year's economic growth rate at 5.1%, down from the July forecast of 6%. Instead, it raised the inflation forecast for both this year and next year to 3.4%.

Considering the current central bank forecasts, the Wall Street Journal (WSJ) reported that an interest rate hike is expected in the second or third quarter of next year. WSJ explained that this is slightly earlier than the previous expectation for the second half of next year, and that Canada, along with the United Kingdom, will be the first among the Group of Seven (G7) countries to raise interest rates after the COVID-19 pandemic. Bloomberg also reported that some investors expect the Bank of Canada to raise interest rates as early as January next year.

Governor Macklem said, "We will need to consider raising interest rates sooner than expected," adding, "If the economy recovers and inflation rises, there is no need to keep interest rates low any longer."

Following the unexpected decision to stop asset purchases, Canadian government bond prices fell. Investors anticipated a price drop because the major buyer, the Bank of Canada, decided to halt purchases and thus sold Canadian government bonds. The yield on 2-year Canadian government bonds surged by 0.19 percentage points to 1.06%. Bond yields move inversely to prices. With the Bank of Canada's decision to stop asset purchases expected to reduce Canadian dollar liquidity, the Canadian dollar strengthened against the U.S. dollar.