With inflation on the rise, the Bank of Canada kicked its tightening cycle into high gear Wednesday by announcing a 50-basis-point increase in its target for the overnight rate — the first non-25-basis-point hike in over 20 years. It also modified its stance concerning its over-sized holdings of Government of Canada bonds, which swelled its balance sheet during so-called Quantitative Easing (QE). Those days are over: it will now initiate Quantitative Tightening, or QT, by not replacing bonds on its balance sheet as they mature, thus reducing its bond holdings over time.
Some might be disappointed the bank didn’t go further on QT by announcing it would actually start selling its holdings of government bonds. Not to worry. Shrinking the balance sheet is the right signal to send the market but it’s the overnight rate that will have to do the heavy lifting to bring inflation back to target.
The 50-basis-point hike shows the bank understands it has fallen behind the curve in terms of fighting inflation and is now playing catch-up. Headline inflation reached 5.7 per cent in February and has been above its two per cent target for each of the last 12 months and outside its one-to-three-per-cent target range for each of the last 11. The bank’s measures of core inflation have also edged up over the same period: all three are above the two per cent target, while two are above the target range.
The bank now acknowledges that headline inflation is likely to average six per cent in the first half of 2022, though it expects it will decline to 2.5 per cent in the second half of 2023, not returning to the two per cent target until 2024. Its The rate announcement also acknowledged that inflation expectations are becoming less well anchored: “