The Bank of Canada surprised investors by abruptly ending its bond-buying programme on Wednesday and pulling forward its expected timeline for interest rate rises, triggering a heavy sell-off in Canadian government debt.
The announcement puts the BoC at the head of a growing number of central banks that have responded to surging inflation by signalling a shift towards tighter monetary policy. It came as the central bank said “robust economic growth has resumed” in Canada following a pause in the second quarter, as the nation continues to recover from the coronavirus crisis.
“The main forces pushing up prices — higher energy prices and pandemic-related supply bottlenecks — now appear to be stronger and more persistent than expected,” the bank said in a statement.
Policymakers decided to stop adding to the bank’s holdings of Canadian government bonds, bringing an end to a quantitative easing programme that began in the early stages of the pandemic.
The bank kept its benchmark rate at 0.25 per cent, although it forecast that inflation is on pace to hit a 2 per cent target in the second or third quarter of 2022, potentially setting the scene for a rate rise.
Officials have said they are committed to keeping rates at their lower bound until the bank achieves its inflation target. Previously, they expected inflation to hit its target in the second half of next year.
“Higher-than-expected inflation prints and the expected rise in prices from consumers and businesses has put the fear of God into them,” said Karl Schamotta, chief market strategist at Cambridge Global Payments. “I don’t think anyone was expecting this.”
Financial markets had anticipated the BoC would halve the pace of its asset purchases to C$1bn (about $811m) a week rather than stopping them suddenly, said HSBC currency strategist Dominic Bunning.
Investors responded by dumping Canadian government debt, pushing the yield on the two-year Canadian bond, which is sensitive to moves in short-term interest rates, up 0.19 percentage points to 1.06 per cent.
As recently as last month two-year yields traded at just 0.4 per cent, but they have leapt as investors bet on higher rates, echoing similar moves in the UK, Australia and the US in recent weeks.
The Canadian dollar rose by 0.3 per cent in midday trade in New York, ending a four-day decline and approaching a four-month high.
“Beyond the near-term reaction, a further question for the Canadian dollar will be the degree to which the market also looks for a more prolonged hiking cycle,” Bunning said.
The BoC also cut its outlook for Canadian economic growth this year to 5.1 per cent from the 6 per cent it predicted in July.