Bank of Canada cuts rates to 50-year low

Yuri Gripas/ReutersBank of Canada Governor Mark Carney.
OTTAWA - The Bank of Canada surprised markets Tuesday with a deeper-than-expected 75-basis-point cut to its benchmark-lending rate, to 1.5% a 50-year low, as it warned that Canada is entering a recession and global economic conditions are deteriorating at a deeper rate than anticipated.

The last time the central bank cut its overnight target rate this deeply was on Oct. 21, 2001, to deal with the immediate economic fallout from the Sept. 11 terrorist attacks in New York and Washington.

As a result, the Bank of Canada governor, Mark Carney, has lowered its key lending rate by a combined 150 basis points in the span of two months. The last time the bank's key lending rate was this low was in July, 1958.

TD Canada Trust was the first of the country's big commercial banks to move after the Bank of Canada's announcement. It failed to pass on the full cut, taking only 50 basis points off its prime lending rate to put it at 3.5%.

In its statement, the Bank of Canada signalled the domestic and global economies have weakened more than expected. It added it would continue to "monitor carefully" economic data and financial markets to determine whether a further rate cut would be required.

"The outlook for the world economy has deteriorated significantly and the global recession will be broader and deeper than previously anticipated," the bank said. "While Canada's economy evolved largely as expected during the summer and autumn, it is now entering a recession as a result of the weakness in global economic activity. The recent declines in terms of trade, real income growth, and confidence are prompting more cautious behaviour by households and businesses."

These factors, the bank added, "imply" that core inflation will turn out to be lower than previously forecast in its October monetary policy report. In that forecast, it projected core inflation would remain below 2% in both 2009 and 2010. The Bank of Canada sets its benchmark rate to meet a 2% inflation target.

The gloomy outlook comes just days after Statistics Canada reported that job losses in November of just over 70,000, the biggest one-month drop in 26 years.

Andrew Pyle, wealth advisor and markets commentator at ScotiaMcLeod, said he believes the lack of a stimulus package from the federal Conservative government was a factor in the central bank's decision to cut by a deeper-than-expected 75 basis points.

"With no budget until Jan. 27, the prudent move was to cut rates more substantially as an offset, and this plan should yield results provided chartered banks and other lending institutions relax spreads enough to allow this easing to filter through."

The Finance Minister, Jim Flaherty, said he would include fiscal stimuli in his pending Jan. 27 budget, after Opposition parties threaten to take down the ruling Conservatives for failing to include a stimulus package in last month's fiscal update.

Mr. Pyle added the move would be negative for the Canadian dollar in the short-term, but would benefit economic fundamentals in the medium term.

Douglas Porter, deputy chief economist at BMO Capital Markets, said the key element of the bank's statement is that Canada is now in a recession.

"With the bank openly admitting recession is upon Canada, chopping rates hard and pointing to the likelihood of further cuts, and also almost applauding the weaker Canadian dollar, this is even more dovish than expected."

The Bank of Canada cited the recent drop in the Canadian dollar – to the upper-US70¢ range last week – would provide an "important offset" to the effects of weaker global demand and lower commodity prices.

The bank statement suggested moves by governments to inject liquidity into strained money markets are starting to encourage credit flows, especially in Canada. However, it added it would still take some time before conditions in financial markets "normalize."

The consensus among Bay Street economists was for a 50-basis-point cut, although analysts at National Bank Financial were the exception in arguing that negative growth in the United States and rising unemployment suggested a 75-basis-point cut was in the cards.

Stefane Marion, assistant chief economist at National Bank Financial, said the Bank of Canada should be applauded, adding that interest rates are now below core inflation - the first time that's happened since 2002. "That is the necessary step to take when you have a recession."