FX Viewpoint 29 Oct 2021 | CAD: Bank of Canada ended quantitative easing | Article – HSBC VisionGo

CAD: Bank of Canada ended quantitative easing
Finance  ·    ·  6 mins read

  • Surprisingly, the Bank of Canada ended QE, pointing to the possibility of an earlier rate hike
  • The CAD strengthened immediately after the announcement, before giving back some of its gains amid lower oil prices
  • Further CAD gains could be sustainable over the longer term, if terminal rate pricing can be extended, in our view

The BOC decided to stop growing its holdings of Canadian government bonds, bringing an end to its QE programme

On 27 October, the Bank of Canada (BOC) delivered a hawkish surprise by announcing the end of its quantitative easing (QE) programme. As a result, the BOC will enter the reinvestment phase during which it will maintain the size of its holdings of Canadian government bonds by buying bonds of between CAD4bn and CAD5bn per month. Consensus expected a reduction in QE, but not all the way down to zero. 

A rate hike in Canada could come in the middle quarters of 2022, according to the BOC

Policy rate was unchanged at 0.25% as expected. Importantly, the key criteria before raising the policy rate has been pulled forward slightly. Whereas previously the BOC had said that the domestic economy would reach potential “in the second half of 2022,” it now says that this might happen “in the middle quarters of 2022”. Indeed, in the press conference, BOC Governor Tiff Macklem also noted that a policy rate increase could be considered sometime between April and September.

The CAD should be supported by the BOC’s hawkishness over the near term, in our view

The CAD strengthened immediately after the announcement before giving back some of its overnight gains. In our view, the BOC’s decision is likely to provide some near-term support to the CAD, and oil prices will remain part of the equation for the CAD (see the chart below). It is possible for oil prices to extend a rally that has been running in earnest now for 18 months, while our oil and gas analysts see oil prices dropping next year as US supply returns.

The longer-term outlook for the CAD could depend on terminal rate pricing, in our view

Beyond the near-term reaction, a further question for the CAD will be the degree to which markets also look for a more prolonged hiking cycle. Our analysis results suggest that developed market currencies have been responding somewhat more to terminal rates (also known as natural interest rate which refers to the level of interest rate at which economic growth is on par with its potential and inflation is stable) than to shorter-term rates. If markets see the BOC’s hawkishness as a sign that terminal rate pricing can be extended, this would potentially point to more sustainable gains for the CAD, in our view. Yet, the BOC now projects a less favourable outlook, expecting GDP growth of 5.1% this year (down from 6.0% in its July’s projections) and 4.3% next year (down from 4.6%), albeit with faster inflation (3.4% for both 2021 and 2022, up from its July’s projections of 3.0% and 2.4%, respectively).

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