Bank of Canada moves to directly support provincial and corporate borrowing
April 15, 2020
Focus Area—Canadian Economics
The Conference Board of Canada’s Senior Economist Robyn Gibbard offers the following insights on today's Bank of Canada announcement:
“With its overnight rate already at its lower bound, the biggest policy action today was the Bank of Canada’s decision to purchase large quantities of provincial and corporate bonds. In a sign of the unprecedented times we are living in, the Bank declined to publish a standard economic forecast, saying that uncertainty was too high to offer precise projections.”
- The Bank of Canada was scheduled today to reveal its forecast for the Canadian economy as part of its Monetary Policy Report. However, the Bank made the decision not to publish a standard economic forecast with precise projections of economic variables. Instead it outlined a range of possible outcomes falling between a best-case and a worst-case scenario.
- Governor Poloz reiterated that the Bank believes the current policy rate, 0.25 per cent, is the effective lower bound. Further rate cuts are not on the table for the foreseeable future.
- Although the Bank of Canada had previously published research suggesting that the lower bound of interest rates is -0.50 per cent in Canada, it may believe that in the current circumstances the lower bound is temporarily higher than previously calculated. One of the primary factors that determines the lower bound is the sustainability of the banking sector. Given that many Canadian households are carrying large amounts of debt, and our projection that around two million more Canadians will lose their jobs this month alone, there is a risk of rising loan defaults which would pressure bank balance sheets and cutting rates further would put them under even more strain.
- In the absence of rate changes, the biggest policy announcement today was a new program to purchase provincial government bonds. The Bank of Canada was already buying provincial treasury bills and promissory notes through its Provincial Money Market Purchase program (PMMP). Since that program was introduced on March 24, the Bank has purchased $2.3 billion in provincial debt instruments. The new Provincial Bond Purchase Program differs from the existing PMMP program in two ways. First, it is much larger in magnitude, with the Bank planning to buy up to $50 billion in provincial debt through the new program. Second, it is intended to purchase bonds instead of treasuries. Typically, treasuries have maturities between weeks and one year whereas bonds have maturities between one year and decades. The new bond-buying program is therefore a complement to the existing PMMP program, supporting the large-scale, long-term borrowing provinces will need to get through the crisis while the PMMP supports the short-term borrowing provinces engage in to meet immediate spending needs.
- For at least the past few decades, provincial government bonds have been priced lower than underlying fundamentals would suggest. That means that markets have been pricing in an expectation that provincial governments would not be allowed to go bankrupt. We have never had an opportunity to test that before this crisis, but the Bank of Canada's actions today and in the past few weeks have effectively formed a backstop to provincial governments. Even once these measures are wrapped up, the fact that they occurred at all will have an impact on provincial bond pricing for decades to come.
- In addition to the new provincial bond purchase program, the Bank today also announced a new program to purchase up to $10 billion of corporate bonds. Similar to the provincial program, this new program will complement the Bank’s existing commercial paper purchase program.
- In our Quick Take on the previous Bank of Canada announcement, we noted that Governor Poloz declined to characterize the Bank’s asset purchase program as quantitative easing. Today Governor Poloz offered more elaboration on this point, explaining that while their asset purchase program may be indistinguishable from QE on a practical level, the difference is in their objective. In particular, he said that the Bank’s actions to date have been exclusively aimed at ensuring market function. By contrast, he characterized QE’s objective as yield curve control – in other words, controlling the spread in yields on bonds at different maturities. Governor Poloz indicated that the Bank’s primary focus at this time remains market function, but that this type of yield curve control is something they may consider during the recovery period.
- At the time of writing, the Loonie stood at 70.8 US cents. That is about 5 cents below its pre-COVID levels, although Governor Poloz noted that the Loonie has not fallen as far as other currencies.
- The next scheduled rate decision would normally be June 3, 2020. With rates at their effective lower bound, we do not expect any change in rates for the foreseeable future. However, given how quickly economic conditions are changing, it is likely that we will hear from the Bank again before June.
- One final note: today’s rate decision and Monetary Policy Report are supposed to mark the end of Governor Poloz’s term. Despite the ongoing crisis, Poloz re-emphasized that he still plans to step down and that the decision on his replacement is in the final stages. The frontrunners for the post are Senior Deputy Governor Carolyn Wilkins, Poloz’s second-in-command at the Bank of Canada, and Jean Boivin, head of research at Blackrock, the world’s largest asset manager.