Bank of Canada Cautious QE

The Bank Canada announced last month that they were going to lay-out their plan for quantitative easing or alternative monetary policies. It was expected that Canada would go in the same direction as the US. The market was anticipating some "shock and awe" and was trading at the high end of the range for the last two weeks.

The response from the BOC was meekness as measured by the market. The BOC actually refrained from making a strong policy stand other than to say that if the outlook gets worse it will take some quantitative action. There next meeting is June 4. Of course, you wonder what it will take to get them to move in this direction. First, the interest rate target is now down to 25 bps and is expected to stay there for at least a year. The eocnomy is not looking good but the story is mor emixed than other places. On th negative side, leading indicators have fallen to lower levels than expected. Howeve, retails ales are still positive and slightly higher than expected. Core CPI is still around 2% so the real rate of interest is still negative.

While the market rallied hard on the no news, the BOC did a good job of laying out a fremworks for their decision-making which is clear. Outlined by Reuters:

GUIDING PRINCIPLES

- Focus on inflation target

- Concentrate asset purchases in a maturity range where they will have maximum impact on the economy

- In private credit markets, focus on those exhibiting market failure, evidenced for example by excessive liquidity premiums, that have significant macroeconomic consequences

- Neutrality across sectors and across similar assets

- Act with prudence by taking into account investment quality and by minimizing operational risks

KEY INDICATORS

- Most important would be indicators showing the effect of actions on financing conditions faced by households and businesses, and thus on aggregate demand and inflation

- The flatness of and movements in the yield curve

- The bank's Business Outlook Survey and the Senior Loan Officer Survey

- The bank's new Financial Conditions Index

- Credit and monetary aggregates

EXIT STRATEGY

The bank outlined a number of alternatives:

- Natural runoff through the maturing of assets

- Refinancing of acquired assets (e.g., financing in the repo market or allowing the runoff of other assets on the Bank of Canada's balance sheet)

- Asset sales, which it said would only be done "at an appropriately measured pace"

If you follow the consensus and it is wrong, the cost can be high.