–BOC Decides to End Quantitative Tightening; To Restart Asset Purchases in Early March
–Governor Macklem: We Are Long Way from Needing Quantitative Easing
–Macklem: USD/CAD Affected More by US Trade Policy Uncertainties Than by BOC’s Cumulative Rate Cuts
By Max Sato
(MaceNews) – The Bank of Canada trimmed its policy interest rate – the target for overnight lending rates – by a more gradual pace of 25 basis points to 3.0% in a pre-emptive move to help shield the economy from the threat of stiff tariffs on its exports to the United States.
The latest action follows two consecutive 50-basis point cuts, in December and October, and three 25-basis point cuts since June when the bank began unwinding the effects of its past aggressive tightening. It has now delivered a total 200 basis points (2.0 percentage points) in credit easing in just seven months.
The bank also announced its plan to complete the normalization of its balance sheet, ending quantitative tightening. It will restart asset purchases in early March, beginning gradually so that its balance sheet stabilizes and then grows modestly, in line with growth in the economy.
The BOC will restart its term repo program on March 5 and operations will be conducted every two weeks. Terms will alternate between 1-month operations and 1- and 3-months operations depending on the week. Initially, term repo operations will range between C$2 billion and $5 billion.
The sizes will increase over time as the bank’s needs for additional assets grow. Final operational details, including the size and specific maturity date of the term repos, will be published a week prior to the operation date.
“The cumulative reduction in the policy rate since last June is substantial,” the bank said, repeating its recent view. “Lower interest rates are boosting household spending and, in the outlook published today, the economy is expected to strengthen gradually and inflation to stay close to target.”
“However, if broad-based and significant tariffs were imposed, the resilience of Canada’s economy would be tested,” the bank said.
At a post-meeting news conference, Governor Tiff Macklem repeated his remarks from last month, saying the U.S. trade policy is “a major source of uncertainty” and that “there are many possible scenarios”: It is not certain what new tariffs will be imposed, when or how long they will last, and nobody knows the scope of retaliatory measures or what fiscal supports will be provided.
Macklem said he will closely monitor news from Washington on Feb. 1, when U.S. President Donald Trump is expected to announce his much-advertised plan to impose a 25% tariff on all goods from Mexico and Canada.
“Having restored low inflation and reduced interest rates substantially, monetary policy is better positioned to help the economy adjust to new developments,” the governor said. “As always, the bank will be guided by our monetary policy framework and our commitment to maintain price stability over time.”
Asked whether reviving quantitative easing (buying large sums of government bonds and other financial assets) is the cards to ward off what could be a severe negative impact of the Trump tariffs, the governor responded in a firm tone: “We are a long way from needing quantitative easing.”
In the bank’s recent review of its own usage of QE during the pandemic, “What we concluded was that the bar for using quantitative easing in Canada has always been very high, and in fact we’ve only used it once.”
Monetary policy “cannot offset the economic consequences” caused by trade rows but it can help economy “adjust” by providing a source of stability, Macklem said.
The Canadian economy would fall into recession in a severe scenario under which the U.S. imposes 25% tariffs on all of its trading partners and all of them respond with 25% retaliatory tariffs, the governor projected.
But he said he could not give a definitive answer to what to do with interest rates when stiff U.S. tariffs are imposed, adding it would be is a “complex shock” because growth is set to fall while inflation will rise.
The governor said the recent USD/CAD exchange rate has been more influenced by U.S. trade policy uncertainties than by the BOC’s consecutive rate cuts, noting that the weaker Canadian currency makes imports of foodstuffs, machinery and equipment from the U.S. more expensive.
In its quarterly Monetary Policy Report, the Bank of Canada forecast that GDP growth will strengthen from 1.3% in 2024 to 1.8% in 2025 and 2026. GDP growth per person is projected to pick up as lower interest rates and rising incomes support spending. The projected increase in overall GDP growth is more modest than it was in October, largely due to lower population growth that reflects new federal immigration policies.
There are risks around the bank’s outlook, and “Governing Council is equally concerned with inflation rising above the 2% target or falling below it,” the bank said in the report. Absent the threat of tariffs, the risks to the inflation outlook are “roughly balanced.”
The economic outlook presented in this MPR does not incorporate any new U.S. tariffs, although it does recognize that the threat of tariffs is already affecting financial markets and business decisions.
The new U.S. administration has threatened significant tariffs on imports from its trading partners, including Canada. This has prompted discussion of retaliatory tariffs. While many details remain unknown, broad-based tariffs would severely disrupt global trade. In Canada, there are already signs that the threat of tariffs is weighing on consumer and business confidence and investment intentions, the bank said, adding that the threat has also contributed to the recent depreciation of the Canadian dollar.
The key forecasts from the MPR:
Canada 2025 CPI +2.3% (+2.2% projected in October); 2026 CPI +2.1% (+2.0%)
Canada 2024 GDP +1.3% (+1.2%); 2025 GDP +1.8% (+2.1%); 2026 GDP +1.8% (+2.3%)
Q4 2024 GDP annualized rate +1.8% (+2.0%); Q1 2025 GDPs +2.0% (the first estimate)
The BOC’s inflation watch is not just over yet, although it has brought it down from a recent peak of 8.1% hit in June 2022 by jacking up borrowing costs and cooling off the economy.
Inflation in Canada measured by total CPI eased to 1.8% December from 1.9% in November after accelerating to 2.0% in October from September’s 1.6%, which was the lowest since 1.1% in February 2021. Now it is half of the corresponding rate in Japan but the core readings are still at 2.4% in median and 2.5% in trim, and as Porter points out, the three-month average in the two core measures has perked up to just above 3.5% annualized, above 3.0% in Japan’s core CPI (excluding fresh food).
The deceleration in consumer inflation was clearly caused by Ottawa’s two-month sales tax break on certain goods until mid-February, which led Canadians to pay less for restaurant food, alcoholic beverages purchased at stores as well as toys and games at the end of the year. CPI data will see similar decline in the prices of some goods in January but inflation is likely to pop once the tax holiday is over.