–BOC’s Gravelle: Quantitative Tightening Likely to End in late 2024 to Early 2025
By Max Sato
(MaceNews) – It is too early to discuss normalizing the Bank of Canada’s high policy interest rate because consumer inflation at 5.2% remains well above its 2% target, although it has eased from its recent peak of 8.1% hit last June, BOC Deputy Governor Toni Gravelle told the National Bank Financial Services Conference in Montreal on Wednesday.
In a speech, Gravelle stressed the need to “remain nimble in response to the uncertain times we’re in.” In the past month, headline inflation has dropped, and the risk appetite in global markets has pulled back, partly reflecting the increased stress in global banking, he said.
“At the same time, the labour market in Canada remains tight and this is putting upward pressure on many services prices,” Gravelle said. “We continue to expect consumer price index (CPI) inflation to come down in the months ahead, but we will need to see further slowing in core inflation to get CPI inflation back to the 2% target.”
The bank is still in the process of bringing aggregate supply and demand back into balance, Gravelle said. “Our main tool for doing this is our policy interest rate, which we have increased forcefully — from 0.25% to 4.50% in less than a year. But our balance sheet must continue to normalize to remove the support it provides to monetary policy,” he explained.
In its latest policy decision on March 8, the BOC left its policy interest rate — the target for overnight lending rates — at 4.50%, as widely expected, but stressed that it is not lowering its guard against upside risks to inflationary pressures as labor market conditions remain “very tight” and consumer spending is resilient.
BOC policymakers have said it is a “conditional pause” in monetary tightening.
During question-and-answer session, Gravelle repeated recent remarks by Governor Tiff Macklem that it would be too early to discuss when the bank should consider cutting interest rates to support the economy.
Normalizing rates would be in a different context now, compared to the time when the very low rate of 0.25% would have to be raised to a neutral rate of 2.5%, for example, Gravelle said.
“Hopefully, over time if inflation does follow the path that we projected in the January MPR (Monetary Policy Report), there will be a time in the later part of the projection period that we might need to normalize rates in the other direction from high levels towards lower levels,” he said.
“But at this stage, it’s way too early to talk about the normalization coming down part, given the current context that we are in in terms of high inflation that being we are not near anywhere near the 2% inflation target.”
Gravelle said the bank’s policy board took a “conditional” pause in hiking rates to assess more data as to how last year’s aggressive tightening is slowing the economy after seeing signs of a slowdown in the housing sector.
BOC policymakers are more concerns about any positive shock that increases aggregate demand or growth, he said. “We have heightened concerns to the extent that the data comes in hotter, or more positive for growth, and we’d react more to that and would do a series of shocks to reduce aggregate demand.”
On the other hand, Gravelle said in the speech, “We are also keeping a close eye on stresses to global banking systems as we turn our attention to the April Monetary Policy Report.” He was referring to the bank’s quarterly report due on April 12, when the bank also releases its latest monetary policy decision.
“We will consider the macroeconomic impact of this evolving situation as we put together our next projection,” he said. “We’ll be looking specifically at potential spillovers into the real economy to the extent that financial conditions tighten and there are broader confidence effects.”
On how the bank should conduct asset purchases differently in the future after reviewing its emergency measures taken during the early stage of the pandemic, Gravelle said, “We’d be very clearly identifying when we will be rolling out bond purchases for market functioning versus identifying bond purchases for monetary policy.”
At the outset of the global pandemic, the bank used extended term repo operations, which were held more often and for larger sizes than usual, to support market functioning. The bank lent roughly C$210 billion to financial institutions from March to June 2020.
At the same time, the bank launched the Government of Canada Bond Purchase Program, first as a market functioning tool and then later as a monetary policy tool. It boosted the GOC bond holdings on the central bank balance sheet to roughly C$440 billion at its peak.
To unwind excess monetary policy support provided at the peak of the pandemic, the bank began the process of normalizing its balance sheet through quantitative tightening (QT) about a year ago, when the bank decided to implement monetary policy using a floor system — or an ample reserve system — on a permanent basis.
The amount of settlement balances — or reserves — needed to operate in a floor system is somewhat above the long-term level demanded by the banking sector.
“Some of you may be wondering what that ideal level might be. The answer is not yet set in stone,” Gravelle said.
“We know it will be well below our current level of roughly $200 billion,” he said. “Our best estimate is somewhere in the range of $20 billion to $60 billion, or roughly 1% to 2% of Canadian gross domestic product (GDP).” By comparison, the US Federal Reserve’s longer-run level of reserves needed has recently been estimated to be roughly 10% to 13% of the U.S. GDP, he added.
“This implies that QT will have run its course once our settlement balances have reached this $20 billion to $60 billion range. At that point, the bank would start buying assets again as part of our regular balance sheet management process,” Gravelle said.
“As for the question of when QT will end, this will likely occur sometime around the end of 2024 or the first half of 2025. This is based on the maturity structure of our current bond holdings combined with the estimate of what our steady-state holdings will likely be.”
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Contact this reporter: max@macenews.com
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