10:51 AM EDT, 06/13/2024 (MT Newswires) -- Deputy Governor Sharon Kozicki delivered a speech Thursday at a CABE event in Ottawa on the evolution of the Bank of Canada's (BoC) extraordinary measures, noted Desjardins.

Kozicki cited research from staff at the central bank which suggests that 10-year Government of Canada (GoC) bond yields could have been as much as 80bps higher if the BoC hadn't conducted quantitative easing (QE). That seems high even though the program was incredibly large for the size of the Canadian bond market, said Desjardins.

As quantitative tightening (QT) continues now, and bonds mature and roll off the BoC's balance sheet, the bank doesn't expect 80bps of term premium to be reintroduced back into the market. To be fair, Kozicki did mention that estimates ranged from 20bps to 80bps, although she seemed to favor the latter number.

The BoC intends to end QT sometime in 2025. The analysis of Desjardins suggests that settlement balances will reach the top end of the BoC's desired range in the second half of the year. That said, the central bank probably won't be buying bonds for normal balance sheet operations until 2026.

Officials have outlined a plan to first purchase term repos to replace maturing bonds and normal balance sheet growth. After that, they will move on to T-Bills. Only after refilling their balance sheet to sufficient levels with those assets will they begin buying bonds once again, pointed out the bank.

The reduction in duration held on the BoC's balance sheet over the next couple of years should support a steepening yield curve by putting more product in the hands of private sector players and, as such, pushing term-premiums on bonds higher.

The BoC plans on conducting a comprehensive review of the extraordinary measures taken during the pandemic. That said, Kozicki might have let the cat out of the bag when she said that the bar for employing QE again is very high, added Desjardins.

The BoC had difficulty calibrating the policy in the fog of COVID-19. Instead of focusing on the size of the bond market, central bankers chose to look at the size of the economy to determine how much bond-buying would be needed. In the end, that resulted in a much larger than necessary program which was clearly counterproductive given the surge in inflation, even if policymakers point to supply-chain disruptions as the main cause of the spike in prices.

For now, the focus remains on the policy rate, according to Desjardins. With a 25bps rate reduction last week, Kozicki reiterated that it's reasonable to expect further cuts assuming inflation continues to decelerate. The reason to continue QT while also cutting rates (easing policy) comes down to the different objectives of the two.

QT aims to return the balance sheet to a more normal size and composition, so reducing the BoC's footprint in the bond market. While it does have monetary policy spillovers, that's not the main objective. The main tool for adjusting the stance of monetary policy is interest rates. That's why lower inflation has led to lower interest rates, a trend that should continue, noted the bank.

Desjardins expects another three rate cuts this year and six in 2025.