Bank of Canada cuts rate by quarter point

Reduction in growth forecasts 'startling'

Published: Tuesday, October 21, 2008

The Bank of Canada cut its benchmark-lending rate Tuesday by a quarter point, citing an "uncertain" outlook for growth and inflation that poses "significant risks" to the economy.

It also indicated that another reduction "will likely" be in the offing.

The bank's accompanying statement, analysts say, was "quite blunt" about the impact the global financial crisis will have on Canada, and included a "startling" downward revision in growth expectations.

As a result of Tuesday's move, the Bank of Canada overnight rate stands at 2.25%.

The central bank warned that the turmoil in credit markets would "restrain growth for some time," and added the global economy "appears" headed for a "mild recession," which economists consider to be output of less than 3%. That global downturn, it said, is led by a U.S. economy "already in recession" -- making the Bank of Canada one of the first main financial authorities to declare the United States to be in such a state.

The Bank of Canada now projects Canada will record weak growth, of 0.6%, for both this year and next, an indication the country may avoid a recession, or two consecutive quarters of contraction. But this remains in stark contrast to the central bank's initial outlook, which was growth of 1% this year and 2.3% in 2009.

"The Bank of Canada reduced its forecasts ... by a startling degree," James Marple, an economist at Toronto-Dominion Bank, said.

The central bank noted that in the short-term, the "sizeable" depreciation in the Canadian dollar, now trading in the low-US80 cent range, will "provide an important offset" to the effects of weaker global demand and lower commodity prices.

The Bank of Canada was the first central bank among the half-dozen that participated in the co-ordinated 50-basis-point cut on Oct. 8 to move on rates. The majority of economists expected a rate cut on Tuesday, though most believed the cut would be deeper, 50 basis points instead of 25.

With this latest cut, the Bank of Canada has reduced its benchmark-lending rate by 225 basis points since last December. There is now an expectation that the central bank may cut another 25 basis points at its next meeting, on Dec. 9.

It is unclear whether the country's chartered banks will pass on Tuesday's rate cut to its customers, because of the way the global credit crunch is squeezing their own cost of capital.

The statement accompanying the Bank of Canada's decision provides a glimpse of the central bank's economic outlook, which will be spelled out in full Thursday in its latest edition of its monetary policy update.

"The weaker outlook for global demand will increase the drag on the Canadian economy from exports," the bank statement said. "Lower commodity prices will also dampen the outlook, working through a deterioration in Canada's terms of trade to moderate domestic demand growth."

The central bank said that inflationary pressures "will ease significantly," largely on the back of "sharp declines" in commodity prices. It now projects core inflation will remain below its 2% target until the end of 2010. (The bank aims to set its benchmark rate to bring inflation to 2%.)

"In line with the new outlook, some further monetary stimulus will likely be required to achieve the 2% inflation target over the medium term," the bank said. "The evolution of the financial crisis, its impact on the global economy and the timing of the effects of the various extraordinary measures being taken to address it pose significant risks to [the bank's] projection on the both the upside and the downside."

Michael Gregory, senior economist at BMO Capital Markets, said the bank's statement was "quite blunt" in terms of the impact the global financial crunch is having on the domestic economy. Mr. Marple of TD noted the bank's comments were "much-less guarded" than what market participants have come to expect.

In 2010, the Bank of Canada expects "above-potential" growth of 3.4%, based on improved credit conditions, stronger global growth and the lagged effects of monetary policy.