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Interest rate hike will depend on economic recovery, Bank of Canada says

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The Bank of Canada says it plans to increase interest rates before it reduces the size of its government bond holdings, although its timing on the rate hike will depend on the economic recovery.

The central bank is currently purchasing government bonds at a rate of $2 billion per week.

Governor Tiff Macklem says the bank is eventually heading for what it calls a reinvestment phase, where it can limit its bond-buying program to only replace maturing bonds with their proceeds.

During that phase, Macklem says bond purchases would average around $1 billion per week.

Read more: Bank of Canada holds key rate, warns 4th COVID-19 wave could hamper recovery

He says when the bank reaches the reinvestment phase, it expects to remain there at least until it raises its policy interest rate.

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The bank has said that it will keep its policy rate at what it calls the effective lower bound until the economy is strong enough, which it projects will be in the second half of next year.

“When we get to the reinvestment phase and how long we are in it are monetary policy decisions that will depend on the strength of the recovery and the evolution of inflation,” said Macklem.

“The governing council continues to expect the economy to strengthen in the second half of 2021, although the fourth wave of COVID-19 infections and ongoing supply bottlenecks could weigh on the recovery,” said Macklem in prepared remarks to the Federation des chambres de commerce du Quebec.

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Macklem said the economy is showing good momentum heading into the third quarter of 2021, but supply chain issues, rising COVID-19 cases and weak export numbers led to the Canadian economy contracting by roughly one per cent in the second quarter.

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“But consumption, business investment and government spending all contributed to growth, with total domestic demand growing at more than 3 percent,” he said.

The governor said there is still much excess capacity in the Canadian economy, which is why the bank’s current policy interest rate remains.

The Bank of Canada’s key policy interest rate currently stands at 0.25 per cent.

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