Bank Of Canada To Raise Interest Rates Before Tapering Bond Purchases

The Bank of Canada has released its first guidance on how it plans to reduce monetary stimulus, saying it will first raise interest rates before reducing its government bond purchases.

In his latest speech, Bank of Canada Governor Tiff Macklem reiterated that the central bank intends to bring its bond purchases to a roughly neutral pace where holdings and stimulus levels remain stable and keep it there for a "period of time" before it begins withdrawing support from the economy.

When policymakers start paring back that stimulus, the first move will be to increase the central bank’s trendsetting interest rate rather than reducing bond holdings, Macklem said.

"When we need to reduce the amount of monetary stimulus, you can expect us to begin by raising our policy interest rate," Macklem said in remarks prepared for a speech to the Quebec Chamber of Commerce. "What this all means is it is reasonable to expect that when we reach the reinvestment phase, we will remain there for a period of time, at least until we raise the policy interest rate."

The Bank of Canada has been using two major tools to keep borrowing costs low for Canadians: maintaining its main overnight policy rate near zero (0.25%) and buying hundreds of billions of government bonds from investors to keep longer-term borrowing costs in check.

The central bank has bought $336 billion in Canadian government bonds under its asset purchase program, also known as quantitative easing. It started buying $5 billion a week initially but has since tapered those purchases three times to bring it to the current level of $2 billion a week.

The plan outlined by Macklem is consistent with what economists and markets have been anticipating -- a final taper later this year to bring net purchases of bonds to zero, followed by a first interest rate hike in 2022.

In his speech, Macklem said the central bank believes it will need to continue buying about $1 billion a week in government bonds to keep its holdings at stable levels during the reinvestment phase, or about $4 billion to $5 billion per month. The reduction in purchases will take place in both the primary and secondary markets, he said.

In its latest interest rate decision earlier this week, the Bank of Canada maintained its key benchmark rate at 0.25% until the economy is fully recovered and inflation has sustainably returned to the central bank’s 2% target, something it doesn’t see happening until the second half of next year (2022).