Canadian governor says central bank can buy corporate bonds outright

Bank of Canada governor Stephen Poloz issued a statement making it plain that the bank has the authority to purchase corporate bonds outright.

His words prompted speculation from observers that the Canadian central bank may be considering the use of quantitative easing (QE), which it has never previously implemented. 

Last week, Poloz published a statement that made small adjustments to the wording of the Central Bank Act. The changes aimed to more explicitly communicate the central bank’s authority to purchase corporate bonds outright.

Poloz said the central bank can “buy or sell securities and instruments outright or engage in buyback transactions for the purposes of addressing a situation of financial system stress that could have material macroeconomic consequences”. 

It listed the securities the central bank was authorised to purchase, including corporate bonds, state government bonds and banker’s acceptance bills, among others.

This authority has been in place until at least the last time the Bank of Canada Act was amended in 2015, which suggests the governor’s statement may be a signal that policy-makers are considering launching a QE programme.

Josh Nye, senior economist at Royal Bank of Canada, told Central Banking that if financial market pressures continue, the central bank may begin a QE programme.

Poloz’s statement may have been part of preparing for such a programme, the analyst argued. “The central bank was likely just making sure the language was clear so that if it needs to purchase those securities through a QE programme it has crossed all of its ‘Ts’ and dotted its ‘Is’,” Nye says. 

The Bank of Canada has not implemented QE in the past. Instead it has opted for a milder “buyback scheme” or traditional repo operations to increase liquidity in targeted markets.

The buyback scheme sees the central bank switch liquid bonds that it holds for illiquid bonds held by private sector firms.

Financial stress continues

The central bank’s new emergency liquidity facility market, meanwhile, saw heavy demand on March 23, suggesting that stresses seen last week are unabated.

In a sign of continued financial market stress, Canadian lenders bid aggressively for funds in the central bank’s newly-established Bankers’ Acceptance Purchase Facility (BAPF). The demand raised the average rate paid to 1.57%, well above the central bank’s minimum rate of 0.63%.

The facility purchases a pre-set amount of bankers’ acceptance bills, a bank-backed promise of a future payment between two firms. They are typically used in foreign trade when firms potentially do not trust each other.

The banker’s acceptance market is a major funding market in Canada and an important source of financing for small and medium-sized firms.

Last week, spreads in the short-term banker’s acceptance market against risk-free rates increased sharply. The medium to longer-term corporate bond rates against risk-free rates also increased dramatically last week, which is another key finding market for Canadian firms.

“The BAPF facility is intended to add some liquidity to keep those spreads from winding too much and so the bank’s rate cuts are being passed onto corporate borrowers,” Nye said. 

The central bank’s moves come after four of Canada’s largest banks cut their projections for Canadian GDP growth this year. All four – Scotiabank, Toronto-Dominion, Canadian Imperial Bank of Commerce and Bank of Montreal – are now all projecting a contraction in activity.

Last week, more than 500,000 Canadians filed for employment insurance as firms close or are forced to lay off workers due to the coronavirus.