The Bank of Canada is ready to act if severe market-wide stress arises, offering liquidity support to the entire financial system. Deputy Governor Toni Gravelle emphasized the bank’s role in managing monetary policy, particularly in extreme market situations, while speaking to reporters recently. He acknowledged that the government of Canada (GoC) bond market could face severe dysfunction. However, the bar is very high for the bank to use large-scale GoC bond purchases to support market functioning again. It would only offer extraordinary liquidity in extreme market-wide situations, when the entire financial system was faced with funding constraints.
Gravelle also commented on the quantitative tightening program, stating that it would likely end sometime around the end of 2024 or first half of 2025. While the program is working, it needs time to run its course. Additionally, penalty pricing should be built into extraordinary actions whenever possible to discourage financial institutions from exploiting such support, once financial conditions improve.
If the bank were faced with a UK-style pension fund crisis, it could use its contingent term repo facility, which would lessen the need for outright bond purchases. Also, the bank estimates that C$20 to C$60 billion is an appropriate range for its balance sheet, a level much lower than the current C$200 billion value.
Gravelle’s remarks, which also addressed the spillover effects of external events and risks to Canadian banks, did not move the USD/CAD. The forex pair was last seen losing 0.15% on the day at 1.3580.
The Bank’s Future Plans
The global economy is facing various challenges, including sluggish growth, trade tensions, and a low-interest-rate environment. While the Bank of Canada has left its benchmark interest rate at 1.75% since October 2018, a recent Reuters poll predicted that further rate cuts could occur in 2020, as both Canadian and global economic growth are expected to remain weak.
Gravelle’s comments indicate that the bank is prepared to provide support, if necessary. Other central banks, including the US Federal Reserve, have also emphasized their readiness to act if significant financial stress arises. This eagerness to provide liquidity support demonstrates central banks’ concern that a deeper slowing of the global economy could have considerable negative consequences, including the financial market disruptions and concerns that amplify economic issues.
Quantitative Tightening
The Bank of Canada is unusual among central banks in using a “progressive” quantitative tightening policy, which is a gradual withdrawal of its monetary stimulus. The bank indicated in its October 2019 policy statement that its balance sheet would continue to shrink until June 2020 as part of its regular market operations.
Increasingly, economists are predicting that despite Gravelle’s comments, the Bank of Canada will perform a U-turn, cutting interest rates this year to boost inflation to its desired target, causing a pause in their fiscal policies. However, Gravelle did affirm that the bank has no new data on the Canadian economy in their possession, and that, for now, they will use projection models.
Financial Stress Testing
Central banks also conduct stress testing of financial institutions to ensure they are prepared to face extreme market shocks. Stress testing is a process where the bank uses various scenarios to assess the strength and resilience of financial institutions if challenging economic conditions arise. This process is essential to ensure the safety and stability of the financial system.
In conclusion, the Bank of Canada’s Deputy Governor Toni Gravelle has reassured investors that the bank is ready to act if needed. The bank could offer extraordinary liquidity in extreme market-wide situations, provided that conditions are met. The bank’s ability to provide support demonstrates its concern with potential global economic challenges and its commitment to address them. Finally, economists predict that the Bank of Canada will perform a U-turn, cutting interest rates this year.
