Bank of Canada’s Governor Macklem held a speech yesterday regarding the implications of the COVID-19 for Canadian monetary policy and what market participants should expect.
In a week with light economic data, the message sent by BOC’s Governor was crystal clear – the bank will prefer quantitative easing over negative rates.
What to Expect from Bank of Canada?
BOC quickly dropped the interest rate to 0.25% in March, in a measure designed to provide interest rate relief and support confidence. Effectively, since March, the Canadian policy rate sits at its lower bound.
Lowering the interest rate to the lower bound has been a move followed by all major central banks across the world. This was the first reaction in the early days of the pandemic, and then each jurisdiction carefully chose the next steps – quantitative easing, negative interest rates, corporate bonds buying, TLTROs.
Just like its Southern neighbor, BOC’s next step was to launch quantitative easing (buying commercial paper, Canada Mortgage Bonds, bankers acceptances, federal and provincial government debt, corporate bonds). Moreover, in yesterday’s speech, Macklem made it clear that BOC follows a model closer to one of the Federal Reserve in the United States.
The Fed indicated that it favors other ways to stimulate the economy, rather than the use of negative interest rates – and so did BOC’s Governor the other day. According to Macklem’s message, BOC perceives negative interest rates as distorting market behavior.
Instead, the bank buys CAD5 billion worth of bonds every week, with the intent to run the program until the economic recovery is well underway. The idea is to lower government bond yields by keeping a strong demand for bonds. As a consequence, borrowing becomes cheaper for businesses and the population. For the latter, for example, fixed-rate mortgages become more accessible.
Besides government-issued bonds, BOC also buys corporate bonds, albeit not in the same quantity as government ones. Therefore, businesses will end up paying lower interest rates as the premium between government and corporate bonds yields decline.
All in all, the message was meant to ensure investors that BOC is there to contain the risks. Its actions are unprecedented in size and, in some areas, in nature.
However, something was missing from Macklem’s speech – the price of oil and how BOC sees the current conditions. For an energy-driven economy, that is the wild card that may change the monetary policy direction in a blink of an eye.