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The Bank of Canada’s millions in balance-sheet losses are only the beginning

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The Bank of Canada’s recently released third-quarter financial results showed that for the first time, the bank incurred a net loss of $511-million.Sean Kilpatrick/The Canadian Press

Sonja Chen and Trevor Tombe are professors of economics at the University of Calgary.

While the full effects of the Bank of Canada’s rate hikes are not yet known, there is an immediate effect on the central bank’s own finances: growing interest expenses and large financial losses. The bank’s recently released third-quarter financial results showed that for the first time, the bank incurred a net loss: $511-million. This is only the beginning.

This matters, especially at a time of heightened political attention toward monetary-policy issues.

The bank’s revenue is largely derived from its asset holdings, which mainly included Government of Canada bonds and treasury bills. Prior to the COVID-19 pandemic, these bond holdings cost the bank very little, and their returns normally exceeded bank expenses by a wide margin.

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The pandemic changed this picture dramatically. During the significant disruptions early in 2020, the central bank lowered its target interest rate to 0.25 per cent and began large-scale asset purchases, or what’s called “quantitative easing,” to lower longer-term interest rates. There were many specific programs, but the largest – the Government of Canada Bond Purchase Program – came within weeks of the world’s March, 2020, lockdown. At its peak, this and other purchase programs increased the bank’s balance sheet by well over $400-billion. Not since the Second World War has the Bank of Canada expanded its holdings so much so quickly.

These bonds were largely purchased from financial institutions, and the proceeds were overwhelmingly held by those institutions as deposits – “settlement balances” is the term of art – at the Bank of Canada. And since those deposits earn interest, the rapid increases through this year increased the Bank of Canada’s interest expenses.

In a paper for the C.D. Howe Institute, published Thursday, we capture several plausible scenarios for future changes in Bank of Canada revenue and expenses, and find cumulative losses from 2022-23 to 2024-25 may range from $3.6-billion to $8.8-billion, depending on the scenario.

Should Canadians be concerned?

To be sure, the Bank of Canada is a Crown corporation fully consolidated within the government’s books. Rising interest rates naturally increase government debt-service costs; and the bank’s interest expenses are just that.

Similarly, on the one hand, financial losses do not impede the bank’s ability to conduct monetary policy. It can, after all, create settlement balances on demand to purchase assets, and can adjust its policy rate at any time.

However, financial losses do create a novel communications and reputational challenge for the bank. We are already seeing some political leaders raise concerns.

And confidence in a country’s central bank affects its ability to conduct monetary policy and achieve low and stable inflation. If confidence is high, then individuals and businesses may be more likely to anchor their inflation expectations to the bank’s target, which makes it easier to achieve.

Clear communication will not be easy, though. It can be helped with clear accounting.

There are several approaches. It could accumulate losses in a negative retained earnings account, which it is currently doing. But future amendments to the Bank of Canada Act may be necessary to unwind that appropriately. Alternatively, it could carry negative balances in its reserve account, which would be replenished with future surpluses without the need for an amendment. These options would result in central-bank equity turning negative, however, leading some to (wrongly) conclude the bank is insolvent.

To avoid this, another approach follows the practice of the U.S. Federal Reserve system, which is accumulating losses in a deferred account, and must be paid back before any future surpluses are remitted to the government. This allows the central bank to avoid negative equity. It also makes crystal clear that current losses are offset by future surpluses.

Whatever the eventual details, a better understanding of central-bank finances in Canada among political leaders, policy makers and the public is necessary.

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Loblaw tries explaining rising cost of food, but consumers are not buying it – The Globe and Mail

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  1. Loblaw tries explaining rising cost of food, but consumers are not buying it  The Globe and Mail
  2. The grocery price freeze is over — so brace yourself for even bigger food bills soon  CBC News
  3. Loblaw says it’s not to blame for higher food prices as grocer faces backlash online  msnNOW
  4. Opinion: Loblaw’s lifting of No Name price freeze shows discount grocery in Canada is an illusion  The Globe and Mail
  5. View Full Coverage on Google News

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India’s Adani’s losses swell above $100bn – Al Jazeera English

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  1. India’s Adani’s losses swell above $100bn  Al Jazeera English
  2. Mobius Says Adani Debt ‘Scared Us Away’ From Share Sale  Bloomberg Television
  3. Adani’s Abu Dhabi Investor Says IPO Funds Have Been Returned  BNN Bloomberg
  4. Adani-Hindenburg: Short Seller’s Masterclass in Financial Globalization  Bloomberg
  5. The Adani crisis  The Financial Express
  6. View Full Coverage on Google News

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U.S. Federal Reserve delivers small interest rate hike, signals a ‘couple’ more increases necessary to tackle inflation

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Federal Reserve chair Jerome Powell speaks during a news conference at the Federal Reserve Board in Washington on Feb. 1.Jacquelyn Martin/The Associated Press

The U.S. Federal Reserve increased its benchmark interest rate by a quarter percentage point on Wednesday and signalled that a “couple” more rate hikes are still needed to bring inflation under control.

The widely anticipated announcement lifted the federal funds rate to a range of 4.5 per cent to 4.75 per cent. The quarter-point move is the smallest increase since the central bank began ratcheting up borrowing costs last spring in an effort to curb surging prices.

After a string of oversized rate hikes, the U.S. economy has begun to slow and inflation is showing signs of easing. Fed chair Jerome Powell said on Wednesday that “the disinflationary process has started,” although he warned that it would be “very premature to declare victory.”

“While recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path,” he said in a news conference after the rate announcement.

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While the Fed was unambiguous that “ongoing increases” in borrowing costs are still necessary, financial markets responded positively to Mr. Powell’s relatively optimistic comments about inflation and the U.S. economy.

The S&P 500 finished the trading day up 1.05 per cent, while the Nasdaq Composite surged 2 per cent. Bond markets also rallied, with the yield on two-year U.S. government bonds falling around 0.1 per cent. Bond prices and yields move in opposite directions.

“While previous statements said the Fed would have to determine the pace of future rate rises, today’s statement indicated it will now have to determine their extent,” Desjardins economist Francis Généreux wrote in a note to clients. “Rate hikes aren’t over, but it may be the beginning of the end.”

Members of the Federal Open Market Committee, the Fed’s highest decision-making body, which sets U.S. monetary policy, signalled in December that they expect the fed funds rate to exceed 5 per cent by the end of the year. That would imply at least two more quarter-point hikes.

Mr. Powell reiterated this forecast, although he said future rate hikes would be conditional on incoming economic data. He also pushed back against market expectations that the Fed could start cutting interest rates this year. Interest-rate-swap contracts are pricing at least two rate cuts before the end of 2023.

“The historical record cautions strongly against prematurely loosening policy. We will stay the course, until the job is done,” Mr. Powell said.

The Fed’s insistence that more rate hikes are still needed puts it on a different trajectory than the Bank of Canada.

Last week, Canada’s central bank increased its benchmark rate to 4.5 per cent, but said it expects to hold off further rate hikes. This “conditional pause” suggests that Canadian rates have reached a plateau while U.S. rates will keep marching higher.

The Canadian economy is generally seen as being more sensitive to interest rates than the U.S. economy, given how much of the Canadian economy relies on the housing sector. Canadian mortgages also tend to have five-year terms, compared with 30-year terms in the United States, making homeowners more susceptible to rate increases.

What happens next to U.S. interest rates will depend on the trajectory of inflation as well as the strength of the country’s labour market.

There are plenty of signs that inflation is trending in the right direction. The annual rate of consumer price index inflation in the U.S. was 6.5 per cent in December, down from a 40-year high of 9.1 per cent in June.

Prices for many goods, such as used vehicles, have fallen in recent months, as supply chains have improved and consumer demand has shifted back toward services. Mr. Powell said he also expects housing-related inflation to diminish in the coming months.

The challenge is service prices, excluding housing, which show few signs of decelerating. This is tied in part to rapid wage growth, which is being driven by the ultralow levels of unemployment, which stood at a record low 3.5 per cent in December.

Mr. Powell said unemployment will likely need to rise to slow the pace of service price growth. He expects this to happen in the coming quarters as higher rates work to slow the economy. Although, he suggested that a soft landing was still possible.

“There’s a path to getting inflation back down to 2 per cent without a really significant economic decline or a significant increase in unemployment,” he said.

The European Central Bank and the Bank of England will announce their latest interest-rate decisions on Thursday. The central banks are behind the Bank of Canada and the Fed when it comes to tightening monetary policy, and both are expected to announce further half-point rate increases.

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