The Bank of Canada's latest move may signal higher rates

The Bank of Canada has recently signaled a more hawkish stance than what the market might have anticipated, according to Financial Post.

This indication comes from the central bank's decision to revive a cash-management tool that has not been in use since August 2020, hinting at a reluctance to loosen monetary policy in the near future.

Economist Derek Holt from the Bank of Nova Scotia interprets this move as a sign that the Bank of Canada is possibly leaning towards further tightening rather than easing.

In detail, the Bank of Canada announced its plan to resume auctions of Canadian government cash balances, a strategy seen by some as a method to inject liquidity into short-term funding markets. This approach could allow the central bank to extend its quantitative tightening (QT) program.

Holt suggests that this move, coupled with the ongoing use of various funding tools, such as repo injections, serves as an indirect indication of the Bank of Canada's hawkish inclination.

The central bank commenced its QT program in April 2022, ceasing the purchase of Canadian government bonds and letting its balance sheet contract as these bonds mature. This QT process effectively withdraws liquidity from the financial system.

However, recent strains in short-term funding, as evidenced by the Canadian Overnight Repo Rate Average (Corra) settling above the Bank of Canada's policy rate of five percent, have sparked discussions about the potential need to conclude the QT program sooner than expected.

Despite these strains, the reintroduction of the cash-auction program could provide the Bank of Canada with additional flexibility to continue its QT efforts. The effectiveness of this program in aligning Corra closer to the policy rate is yet to be seen and will depend on its utilization.

With Corra reaching a new high of 5.07 percent before adjusting to 5.05 percent, the market's expectations for rate cuts by the Bank of Canada have been set for as early as July.