End of quantitative easing shadows Liberals’ consultation on managing federal debt

Deputy Prime Minister Chrystia Freeland discusses Canada’s economic recovery in a virtual conversation hosted by the Canadian Chamber of Commerce on October 27, 2021.

OTTAWA – The Bank of Canada’s move to end its pandemic-driven purchases of government bonds to stimulate the economy, and warnings of rate hikes sooner than previously expected, has coloured federal efforts to craft an annual plan to mange the debt.

By the bank’s own estimates, its program dropped rates of return on short-term government debt by 10 basis points, or one-tenth of a percentage point.

It also likely made buyers think more about long-term bonds that lock in debt at today’s low interest rates.

Wednesday’s move by the bank to end the program, known as quantitative easing, and foresee a rate hike sooner than expected helped push up returns on short and medium-term bonds.

As rates go up, so too will the amount the government has to pay, which one expert suggests might make the Liberals more cautious about deficit spending and the debt itself.

Rebekah Young, Scotiabank’s director of fiscal and provincial economics, also says federal debt costs should remain low by historical standards even as rates approach pre-pandemic levels, but that could change because of the unpredictability of the pandemic.

The parliamentary budget officer has previously estimated that a sudden rise of one percentage point in rates could increase public debt charges by $4.5 billion, growing to $12.8 billion more after five years.

“I think it will change the language that the government uses and there will be a pivot this year,” Young said of the debt and rising rates.

“Current interest rate paths are going to start increasing and so it would take less of a shock to make those (debt) numbers start to look less palatable.”

In a talk with the Canadian Chamber of Commerce Wednesday, Finance Minister Chrystia Freeland linked government finances to the decision to end pandemic aid for some workers and businesses.

“Your members ? are people who think about the debt, who think about the deficit,” she said. “I want to tell you guys, I do too. Please bear that in mind when you think about our (benefits) announcement last week.”

The government annually consults on how to manage its debt, which now stands at $1.1 trillion. A document setting up the consultations this month hinted at the government interest in how to lock in more debt for longer terms.

Young said there is a limited window for the government to capitalize on these low rates before a mountain of debt matures over the next two fiscal years, which will need to be refinanced at higher rates.

Sherry Cooper, chief economist at Dominion Lending Centres, notes that since September, returns on the federal government’s five-year bond jumped by 75 per cent.

After the bank’s announcement Wednesday, yields on short- and medium-term bonds jumped, but not the end of the interest-rate increases.

The Bank of Canada also suggested it could start increasing its key rate from 0.25 per cent beginning in the second quarter of 2022, three months sooner than previously expected.

BMO chief economist Douglas Porter expects the bank to raise rates every three months by one-quarter of a percentage point starting as early as April, which would bring the target rate to one per cent by the end of next year.

He expects that pace to continue until late 2023, bringing the rate back in line with pre-pandemic levels.

“Clearly, the risks are tilted to an even earlier move, and – yes – the possibility of a faster cadence, and a higher end point,” Porter wrote in a note Wednesday.

This report by The Canadian Press was first published Oct. 31, 2021.

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