Bank of Canada Holds Rates, But It Will Still Drive Borrowing Costs Higher

Canada’s central bank didn’t break its pause, but signaled it will still drive borrowing costs higher. This morning, the Bank of Canada (BoC) announced the overnight rate will hold at 4.5%, surprising few. They did just announce a pause at the last meeting, so reversing course was unlikely. However, that doesn’t mean borrowing costs won’t rise further. The central bank reiterated it will continue quantitative tightening (QT), reducing credit liquidity.

Quantitative Tightening Is Like Quantitative Ease, But In Reverse

To understand quantitative tightening (QT), you first need to understand credit liquidity. A central bank helps manage inflation by influencing the supply and demand of credit. If inflation is too low, the key interest rate is lowered to incentivize borrowing. The goal is to intentionally overrun supply with new demand, driving inflation. Similarly, if inflation is too high, they raise rates to reduce demand, and drive prices lower.

When the key interest rate can’t move further, they turn to unconventional policy. If rates are too low but more liquidity is needed, they use quantitative ease (QE). QE sees the BoC competitively bid up the price of bonds, driving down yields and thus borrowing costs. By flooding the system with money, they reduce borrowing costs, sending investors elsewhere. This helps to lower costs even lower than rates, driving more demand, and inflation.

QT is the opposite of QE, reducing liquidity and increasing borrowing costs. The BoC reduces the bonds it holds by selling, or not replacing them after they mature. This reduces credit liquidity, typically driving borrowing costs higher. A disincentive to borrow and reduced leverage to cool demand and inflation. It does this without higher interest rates, impacting more targeted credit.

The Bank of Canada Is Still Reversing Its Massive Stimulus Injection

The BoC is now in the process of trying to reduce some of the epic stimulus it injected into the system. It used QE for the first time in 2020, increasing the balance sheet by nearly 5x to $575.3 billion in March 2021. That was the peak holding, and as intended—it helped flood the market with excess capital. Shortly after, a generational high for inflation appeared. Mission accomplished, but it might have been a little too effective, requiring undoing. 

Bank of Canada Total Assets

The total value of assets held by the Bank of Canada. 

Source: Bank of Canada; Better Dwelling.

Interest rates didn’t rise today, but the BoC did emphasize it will continue to use QT. Since peaking, the balance sheet has been reduced by 33.6% as of the first week of March 2023. The reduction in 2023 has been particularly sharp, shedding 6.8 points in a little over a month. That would be a major contributor to bond yields rising all of a sudden from the end of January to March. 

The BoC declared a “conditional pause” at the end of the last meeting, so it wouldn’t be a pause if they hiked today. They would look clueless by reversing course already. However, they emphasized they’re working to further reduce liquidity, and throttle credit. It’ll translate into higher borrowing costs, and further demand reduction without a hike.

Though the market is still pricing in another hike later this year.

6 Comments

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  • Mushmo 12 months ago

    The term “quantitative ease” as used in your article is referenced by most (including the BOC) as “quantitative easING,” which is the opposite of “quantitative tightENING” (we don’t say “quantitative tight”).

  • richard 12 months ago

    the value of the loonie will go to hell with the boc and it’s policies. my guess within two years the loonie will go below 65. none of the talking heads and experts are saying that, so let’s see what happens shall we. but of course inflation will remain steady. lies lies and more lies.

  • Brent J Eichler 12 months ago

    IMHO we will never see inflation return to the low levels of the past few decades. The reasons for this are:

    1) We are running out of natural resources – they are getting harder to find, and more expensive to exploit.

    2) Climate change and ecological collapse is destroying food crops and also bringing disease, water shortages, floods, fires, droughts, storms, sea level rise etc.

    3) Demographics

    4) International conflict means onshoring and supply chain issues. International conflict will be made much worse by climate change. inequality, and right wing populism.

  • Craig 12 months ago

    QE was a disaster. QT will just be more of the same: Politicians and Central Bank Hucksters manipulating Fiat Currency to make the Hamster Wheel we run on spin faster.

  • Frank 12 months ago

    BOC look clueless? They are clueless . Once the US raises rates again our looney will drop driving costs of goods higher. Spiking inflation. BOC will hike rates to try and quell. The enormous debt load of Canadian households will crumble if rates go much higher. Job market hot: no wonder. Ppl have taken second jobs. BOC wants to see job loss,or less heated job market. See the problem here?

  • Dennis_K 12 months ago

    This article did a really good job at explaining QE/QT/central interest rates, and what they’re intended to do.

    It makes me wonder however why the BoC even employed these tools in the first place, in response to the pandemic, particularly flooding the economy with more available credit. It seems to me that a lack of ‘consumption’ wasn’t a problem in the pre-pandemic Canadian economy – the accumulation of (consumer and business) debt was.

    Were any jobs actually saved because of lower interest rates and/or credit creation? Or were they saved through government relief programs? Were debts re-financed to lower the overall obligation, to make things easier during and after the pandemic?

    Did any or much of the credit creation during the pandemic get invested into activities that would help our social economy once the crisis passed, and in particular set us up for a just and prosperous society moving forward (i.e. renewable energy, sustainable material technologies, waste minimization, etc.)? I seem to recall many articles over the duration of the pandemic referring to a new ‘Roaring 20’s’ after the pandemic due to Canadian’s $100 – $150 billion in built-up savings – did it happen / is it happening? Or did it go into what is now called ‘inflation’?

    Seems to me that the BoC only has a hammer, and sees every problem ‘stimulating the economy’ as a nail. The response didn’t appear tailored to the reality of the situation.

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