Constant dollars

Bank of Canada ends QE, plunging gold prices in Canadian dollars

So QE ended (so far in Canada, but the Fed will follow suit) and the termination has plunged gold prices into Canadian dollars. Will this be repeated globally?

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Ultimately! Yesterday (October 27, 2021), a central bank ended its quantitative easing program after gradually reducing the pace of asset purchases earlier this year. Don’t panic though – it wasn’t the Fed, the ECB, or the Bank of Japan. It was the Bank of Canada. As can be read in the monetary policy statement:

In light of the progress made in the economic recovery, the Board of Governors has decided to end quantitative easing and to keep its overall holdings of Government of Canada bonds roughly constant.

Of course, the central bank has not said a word about reducing the size of its balance sheet. This is how the dovish bias works: central banks never revert to pre-crisis interest rate or balance sheet levels. Either way, I would like to stress that Canada’s central bank has admitted to underestimating the persistence of inflation, which could stay high next year:

The recent rise in CPI inflation was anticipated in July, but the main forces pushing prices up – higher energy prices and pandemic bottlenecks – now appear to be stronger and more persistent than expected.

More persistent and higher inflation implies earlier tightening of monetary policy. The BoC has indicated that it could raise its main policy rate in mid-2022:

We remain committed to keeping the key interest rate at the effective lower limit until the economic downturn is absorbed so that the 2% inflation target can be reached on a sustainable basis. In the Bank’s projection, this occurs in the interim quarters of 2022.

The direct consequences of the end of the Bank of Canada’s QE should be limited, as the BoC’s actions are not too significant for global financial markets. However, yesterday’s decision is emblematic of the current shift of central banks from monetary easing to monetary tightening. Investors must therefore be prepared for more persistent inflation and a hawkish response from central banks.

Interestingly, while the BoC has just completed its asset purchase program, the Fed is only going to start scaling back its own quantitative easing program. This means that the US central bank is late and late (especially since inflation in Canada is lower than across the border). So, his reaction will have to be stronger in the future. The market expects the first fed funds rate hike to occur in June 2022, thus also in the mid-quarters of 2022, despite the Fed being one year behind the Bank of Canada.

Gold could struggle until the start of the Fed’s tightening cycle. You were warned!

Implications for gold

What does the end of Canadian quantitative easing mean for the gold market? Well, the direct impact on the prices of gold denominated in greenbacks is expected to be minimal. However, the decision to stop QE had a huge impact on the price of gold denominated in Canadian dollars. As shown in the chart below, the price plunged yesterday from around CAD 2,228 to CAD 2,204 in a matter of minutes.

Gold

This drop may be a harbinger of what could happen in the international gold market when the Fed tightens its own monetary policy. Of course, the announcement of tapering at the November FOMC meeting is widely expected. However, keep in mind that the reduction message may also be accompanied by other hawkish signals. So, although gold has been rising recently (see chart below), its difficulties may continue for some time.

gold price

The silver lining is that the decline in the price of gold in CAD – although brutal – was not too deep overall and reversed quickly. To be clear, a 1% drop is relatively large, but it’s not a total disaster, especially given the significance of the event. It appears that inflationary concerns are currently supporting gold prices.

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Arkadiusz Sieron, PhD

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