Bank of Canada – Reduces Prime Lending Rate

General Denise Dunkley 15 Jul

The Bank of Canada cut its overnight rate target by 25 basis points to an historically low 0.5 percent today. The loonie immediately plunged to 77.5 cents U.S., down a full cent. The disparity between monetary policy in Canada and the U.S. is especially evident today as Janet Yellen, Chair of the Fed, is testifying before Congress this morning stating that she expects to raise interest rates in the U.S. this year. 

The Bank of Canada judges that the underlying trend in inflation is about 1.5 to 1.7 percent, below its 2 percent target. Moreover, they substantially reduced their estimate of economic activity this year and argue that the lower outlook increases the risk of further declines in inflation. Earlier this year, the Bank argued that economic growth would revive from the Q1 contraction in the second quarter. This clearly did not happen. Following a 0.5 percent decline in real GDP growth in the first quarter, the Bank is now estimating a further 0.6 contraction in Q2, bringing their forecast for 2015 growth to a mere 1.1 percent , down from their earlier forecast of 1.9 percent.

The disappointment has been in the energy sector and weaker-than-expected exports of non-commodity and no-energy products in the second quarter despite the decline in the Canadian dollar. The Bank points to a slowing in the global economy to explain the weak trade numbers. The U.S. economy experienced considerable weakness earlier this year owing to transitory factors.

Moreover, despite today’s release of 7 percent growth for China in Q2, the Bank attributes lower commodity prices to the weakness in China. I agree and suggest that the Chinese GDP figures are suspect and are likely closer to 6.8 percent (or lower) as most economists expected. Clearly the economy there has been slowing and recent government intervention in the Chinese stock market shows it will stop at nothing to appear to be in control.

The question in my mind is the effectiveness of a rate cut at this time. The follow-through at the financial institutions will likely be partial, as it was with the last rate cut in January. The prime rate and mortgage rates are likely to fall by no more than 10 to 15 basis points from already very low levels. At the margin, this might boost housing and consumer credit a bit, but these are not the sectors most in need of stimulus. Moreover, the Bank reiterated that household imbalances (debt levels) remain elevated and could edge higher. This is obviously a great time for borrowers to lock-in rates.

It is unfortunate that fiscal stimulus is off the table. Much-needed infrastructure spending should be increased as a proactive counter-cyclical measure that would be far more effective than a rate cut from historically low levels. But, alas, that is not going to happen.

The Bank now forecasts that growth will accelerate to a still modest 1.5 percent in the current quarter and 2.5 percent in Q4. Growth in 2016 is now forecast at 2.3 percent, down from the 2.5 percent forecast in April. Even with this rebound, the economy will not return to full capacity until the second half of 2017.

I think we will be lucky to achieve these moderate growth levels. The biggest risk to the global economy is a continued slowdown in China, the number-one commodity consumer, which would put additional downward pressure on commodity prices. As well, the recent nuclear agreement with Iran will, in time, increase oil supply further depressing energy prices.

The Bank of Canada is running out of room. There are now only 50 basis point between here and the zero interest rate boundary. What’s more, the Bank admits that “financial conditions for households and businesses remain very stimulative.” After the October election, fiscal stimulus will be essential.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

There’s a Hint…

General Denise Dunkley 8 Jul

Today in economic news – there is a hint that Government will lower BoC interest rate by .25 basis points as forecasts indicate Canada is on the margin of recession, partially due to low trade between other countries.

*July 15th is the next scheduled Monetary Policy Report and Interest Rate Announcement.