The Bank of Canada has had an untarnished streak of profitability since it was founded, but the recent surge in inflation will likely end that streak.
The central bank said in a statement that it expects the bank's net interest income to be negative in the third quarter. The interest rate that the bank pays on deposits is increasing.
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It is easy to forget that central banks are not different from other financial institutions. The Bank of Canada has a board of directors that oversees management and has a balance sheet with assets and debts.
On the other side of the balance sheet, the central bank earns interest on its assets, while on the other side, the Bank of Canada makes money. The Bank of Canada Act requires the central bank to give its profit to the government at the end of the fiscal year. It has been around $1 billion a year recently.
The Bank of Canada Act is an anti-deflation tactic that uses deposits created at the central bank to buy bonds and other financial assets. The Bank of Canada used quantitative easing for the first time during the crisis in order to keep interest rates low and increase the capacity of banks to lend money.
The Bank of Canada is on the verge of losing money for the first time in its 87-year history, as interest expenses on deposits rise in tandem with the benchmark interest rate, which Macklem has raised by three percentage points since March.
The economy appears to have entered a phase of excess demand at the same time acute supply-chain snarls limited supply of goods, and Russia's invasion of Ukraine sparked a surge in commodity prices, which may have been too much for the economy to absorb. The Bank of Canada has a target of 2% for Canada's consumer price index. Policymakers are trying to get inflation under control by raising interest rates and reversing QE by letting the assets on its balance sheet roll off as they get older.
Some economists believe that a recession will be necessary to contain inflation. One casualty will be the Bank of Canada's net interest income or the difference between revenues from interest bearing assets and liability costs. The coupon rate on bonds was higher than the rate paid on deposits at a time when interest rates were much lower.
It was a profitable strategy when it was first introduced. Net interest revenue at the Bank of Canada increased from 2020 to 2021. Over the two years, the central bank sent the federal government an additional $2.6 billion. The situation has turned around. The central bank expects to lose money for the next three years.
The U.S. Federal Reserve building is located in D.C.
The photo was taken by Chris Wattie.
It is a new challenge for the Bank of Canada, but it is not the only one, as most of the world's major central banks are trying to keep inflation under control.
The Reserve Bank of New Zealand is covered by the government. There is no provision in the Bank of Canada Act that would allow Macklem to keep net income from previous years. The Bank of Canada said in a statement that it has stopped paying interest on government reserves because other central banks have done the same thing.
The Bank of Canada is not in the business of making money and absorbing a loss is an acceptable trade-off, according to Benjamin Tal.
There is no impact on the economy according to Tal. The people don't lose sleep over it.
The large-scale assets purchases the bank underwent over the past two years coincide with its mandate to preserve the country's financial well-being, according to the bank.
The bank's mandate is to keep inflation low, stable and predictable. Policy decisions to manage our balance sheet are not made by us.
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