Bank of Canada cuts to record low 1%
Commercial banks chop prime rates
Paul Vieira, Financial Post Published: Tuesday, January 20, 2009
In the face of an "intensifying" financial crisis, the Bank of Canada cut its benchmark lending rate Tuesday by another 50 basis points, to a record low 1%, on the belief the domestic economy will contract 1.2% this year and experience two quarters in which inflation dips below zero.
The bearish outlook is in stark contrast to the central bank's previous projection, of 0.6% economic growth this year, issued last October. There was also no indication in the fall outlook that total inflation, which includes volatile items such as food and energy, would dip below zero. As a result, total and core inflation are expected to reach the bank's preferred 2% target in the first half of 2011, as opposed to the end of 2010.
The bank also warned that the "stabilization" of the global financial system is a "precondition" for economic recovery.
The updated projections provide a preview of what's in the offing in the latest edition of the central bank's monetary policy report, scheduled for release on Thursday.
The latest reduction means the Bank of Canada has reduced its overnight rate target by 350 basis points in the last 13 months. The central bank indicated it would continue to monitor developments to judge "what extent further monetary stimulus" would be required, leading some analysts to believe another half-percentage-point reduction is coming in March.
Bank of Montreal appeared to be the first chartered bank to match the central bank's move, saying in a statement it was decreasing its prime rate to 3% from 3.5%, effective Wednesday. Most of its competitors quickly followed.
The size of Tuesday's rate cut, anticipated among the majority of Bay Street economists, comes as data suggest weakness in the Canadian economy has spread from the trade sector to household spending and the labour market, and that businesses' assessments of the growth outlook have turned sharply negative. Financial traders had bet the central bank would undertake a deeper rate cut, of 75 basis points, matching its last move on Dec. 9.
"The outlook for the global economy has deteriorated since the bank's December interest rate announcement, with the intensifying financial crisis spilling over into real economic activity," the bank said in a statement explaining its half-percentage-point cut. "Heightened uncertainty is undermining business and household confidence worldwide, and eroding domestic demand."
Industrialized economies, including Canada, are in recession, the bank said, adding emerging market economies, whose demand for commodities drove growth this decade, are "increasingly affected."
Just as the Bank of Canada released its rate decision, Statistics Canada reported that manufacturers posted their biggest monthly sales decline on record in November. Statscan said sales were down 6.4% to $48.4-billion during the month, compared to economists' forecasts of a 2.5% decline.
Based on sharp reductions in exports, and declines in incomes, household wealth and consumer confidence, the bank now projects the Canadian economy to contract 1.2% in 2009. But it expects economic growth to rebound by a healthy 3.8% in 2010, as fiscal and monetary policy actions take hold and a lower Canadian dollar makes our exports cheaper for the rest of the world.
Further, the central bank now believes total inflation is expected to dip below zero for two quarters in 2009, reflecting year-on-year drops in energy prices. It expects core inflation, which removes volatile elements like energy from the equation, to reach a bottom of 1.1% in the fourth quarter.
With inflation expectations "well-anchored," the bank said total and core inflation should return to its preferred 2% target in the first half of 2011. The bank sets its key-lending rate to ensure inflation is at the 2% mark.
In its fall forecast, the Bank of Canada expected inflation of 1% by the second half of this year and core inflation of 1.6%.
"Low, stable and predictable inflation is the best contribution monetary policy can make to long-term economic growth and financial stability," the central bank said.
Pascal Gauthier, economist at Toronto-Dominion Bank, said he expects the bank to cut rates again, by another 50 basis points, at its March 3 decision - and stay at 0.50% for some time. "Given the considerable amount of remaining uncertainty and the fact that the Canadian recession has just started, the rate is expected to stay at this record low well into 2010 before inflation starts registering on the radar again."
