DANIEL FOCH (BETTER DWELLING) - 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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