The Bank of Canada Has No Justification To Continue Extreme Stimulus: BMO

It’s time to take off the training wheels for Canada’s economy, which is now looking overstimulated. That’s the take from BMO‘s Douglas Porter, who sees stimulus coming to an end as early as this week. The Bank of Canada (BoC) is increasingly looking out of touch with reality. BMO, amongst others, now sees no justification for the level of stimulus the central bank is using.

The Bank of Canada Is Out of Step With Housing and The Economy

The Canadian economy hasn’t recovered to its pre-pandemic glory, but it’s not far off either. While it needs help to grow, it doesn’t need this much help from the central bank. Canada’s outlook doesn’t look nearly as bad as it did at the beginning of the pandemic. However, little has changed in terms of the stimulus it’s receiving. 

Programs like quantitative ease (QE) are still used to suppress borrowing rates. The overnight rate is already next to zero (0.25%), but the central bank is driving borrowing costs even lower. By driving down rates, they’re hoping to stimulate even more demand for goods. If demand for goods runs too high, the stimulus becomes inflationary. No one wins when inflation is elevated, since it consumes extra income, but not more goods.

It’s tough to argue for more stimulus with record home and stock prices, and high inflation. Promoting more stimulus would be arguing for higher inflation at this point.

“… [the BoC’s] current ultra-stimulative policies look far out of step with red-hot housing, record equity markets, decades-high inflation, and employment back at pre-pandemic levels,” said Porter. 

The Market Expects The Bank of Canada To Hike 4x Next Year

Whatever the BoC is selling, public markets aren’t buying. Porter said the market is pricing in four rate hikes next year. This can push the overnight rate up to 100 bps higher than its current level. Does that seem realistic? Who knows, and these expectations are volatile in such an uncertain market. The takeaway is the gap between the market’s expectations and the BoC’s narrative. 

Earlier this year, the central bank didn’t expect to hike rates until 2023. They’ve since pulled forward expectations, but only expect one hike next year. “We suspect they push back modestly,” he said. 

The BoC Has No Justification For Stimulus, Will End QE Soon

Let’s circle back to QE. This is the process by which a central bank buys government bonds to drive down yields. By pushing down yields on government bonds, they drive the cost of borrowing lower for all credit. This is most obviously seen by consumers through mortgage rates, which are now negative in real terms. It’s a tool used by central banks to drive inflation higher, when interest rates are close to zero. It acts as a cut to interest rates, without cutting interest rates further.

Canada started the pandemic with an arbitrary number, and it’s only been cut by half. We say arbitrary because the BoC estimates it takes 12 to 18 months for monetary policy to fully hit the market. At the beginning of the pandemic, they decided $4 billion per week was the right number, even with a triple rate cut. They’ve only now seen the full impact of the rate cut, and QE is still at $2 billion per week. BMO sees the central bank turning off the taps to this liquidity soon.

“…There simply is no justification for such extreme stimulus at this point. QE was unleashed at a time of emergency—there is no emergency now,” said Porter.

He further points to the Federal government’s actions over the past week. Wage and labor support programs such as CEWS and CRB now have an end date. In the bank’s opinion, this sends the message that the time for extraordinary support is over.

The Canadian economy is still on course to recover, but it needs time more than stimulus. RBC , Desjardins, and National Bank of Canada also now disagree with the BoC guidance on rates. The central bank is fighting an uphill battle. They need to balance their credibility and market expectations. They can keep saying the market needs stimulus and inflation is transitory. But at this point, who believes them?

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  • astrid 3 years ago

    Yes it does, emperor Justinian has to save the homeowners and their equity even if it means sacrificing everyone else at the the alter.

  • Kate Wright 3 years ago

    Oh, come on. Home prices are only up 60% in Kawartha, what would they do if prices fell 2%? It would be chaos.

    • Felix 3 years ago

      I won’t be complete until Canada warns about the chaos of losing foreign investors in real estate.

      • SH 3 years ago

        Or foreign students. The downtown Toronto and Vancouver rental markets depend heavily on foreign students spiking rents to shove out locals from their own cities.

  • Gerald Haw 3 years ago

    This is a salient point that’s not being made. Was the initial response justifiable, including buying mortgage bonds? No it wasn’t, they were worried prices were going to fall and tried to stop it, and that didn’t work out. Prices went launching into the stratosphere.

    • Felix 3 years ago

      Stephen did a really good talk on how the solution to the previous crisis becomes the issue tackled in the next crisis. I wish they would record and publish them.

  • Randy Webber 3 years ago

    Home prices rise faster as population growth slows and building gets to an all time high, but please do explain why we need lower mortgage rates, Tiff.

  • GTA Landlord 3 years ago

    The reason is Tiff’s portfolio is probably looking lit. Never fails to amaze me how little public scrutiny Canadians demand from their policymakers.

  • Oldguy 3 years ago

    It has been clear since well before COVID that the Liberal policy was going to require all of its supplicants to fall in line behind its efforts to stoke inflation and that is exactly what has happened. COVID was a useful but not necessary step in this process and the strategy has worked.
    But why? The Liberal strategy for 60 years has been to convince the suckers that only the Liberal party can save them from ruin. (We will always have your back). This strategy has always worked in the past and, as sad as it is to say, will probably work again. When the suckers figure out that they have been played for decades it will be too late. The country will be the laughing stock of the world, if it isn’t already. Welcome to one party socialism.

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