Bank of Canada eyes rate hike before reducing bond holdings

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Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, Ontario, Canada December 15, 2020. REUTERS/Blair Gable
Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, Ontario, Canada December 15, 2020. REUTERS/Blair Gable

Bank of Canada Governor Tiff Macklem says an interest rate hike is likely in the cards before reducing bond holdings.

The Bank of Canada launched a massive stimulus program called quantitative easing (QE) to help cushion the pandemic's economic blow.

Macklem says once QE ends, the central bank will focus on reinvesting the proceeds of its holdings of Government of Canada bonds. 

"Eventually, when we need to reduce the amount of monetary stimulus, you can expect us to begin by raising our policy interest rate," he said in a virtual speech at the Fédération des chambres de commerce du Québec.

"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 tapered QE to $2 billion a week but says economic uncertainty remains. The most recent GDP data show the economy contracted in the second quarter. It maintained the current pace of QE and the overnight rate in Wednesday's interest rate announcement.

"The Governing Council continues to expect the economy to strengthen in the second half of 2021, although the fourth wave of COVID-19 infections and ongoing supply bottlenecks could weigh on the recovery," Macklem said.

Benjamin Reitzes, director, Canadian rates and macro strategist at BMO, says he expects the next taper in October, which could also mark the beginning of the reinvestment phase. He also noted Macklem was careful not to make the end of QE sound scary.

"Throughout the QE section of his speech, Governor Macklem stressed that cutting QE purchases is not tightening," said Reitzes.

"He later said that when they do start to tighten, 'our first move will be to raise the target for the overnight rate', so reinvestment could continue for some time."

Macklem also downplayed inflation.

"This year's inflation rate compares prices now with their depressed levels a year ago, making the increase appear more dramatic. In addition, the global supply disruptions I have talked about are leading to higher prices for motor vehicles and other goods," said Macklem.

"We continue to expect that these factors pushing up inflation will be transitory, but their persistence and magnitude are uncertain and we will be monitoring them closely. We are also watching wages and measures of expected inflation."

Jessy Bains is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jessysbains.

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