Another 50bps Cut – Bank of Canada

HEATHER SCOFFIELD
Globe and Mail Update
April 22, 2008 at 9:07 AM EDT

Ottawa – The Bank of Canada is aggressively cutting its key interest rate by another half percentage point, scaling back its expectations for growth in the Canadian economy and not projecting a recovery until two years from now. The central bank’s key rate now stands at 3 per cent, a full 150 basis points lower than where it stood last fall (a basis point is one one-hundredth of a percentage point.). It’s the second month in a row for the new central bank governor, Mark Carney, to cut rates by a dramatic 50 points, despite the bank tradition of moving in 25-point increments. The root cause of Canada’s economic problems is a deepening and lengthy slump in the United States, the bank said in a press release to announce its rate cut on Tuesday. “The bank is now projecting a deeper and more protracted slowdown in the U.S. economy,” the release stated. “This has direct consequences for the Canadian economic outlook, with declining exports projected to exert a significant drag on growth in 2008.” Plus, the credit crunch and falling confidence are hampering business investment and consumer spending in Canada, the bank added. The bank chopped its forecast for real growth in Canada to 1.4 per cent in 2008. Just three months ago, the bank and its army of economists believed Canada would grow by 1.8 per cent. And last October, they thought Canada would largely bypass the American weakness and grow 2.3 per cent this year. For 2009, the central bank now projects 2.4 per cent growth, down from January’s forecast of 2.8 per cent. The central bank did not publish new numbers for its American forecast on Tuesday, but made it clear that U.S. growth was failing to live up to the bank’s earlier expectations of 1.5 per cent in 2008 and 2.5 per cent in 2009. In the past, the bank had suggested that the U.S. economy was on the verge of recession, but has not yet actually used the ‘r’ word. The bank did emphasize, however, that the slowdown and the credit crunch won’t dissipate easily or quickly. Canada won’t see a full recovery until 2010, when it rebounds with 3.3 per cent growth as the United States gradually emerges from its funk and credit conditions return to normal, the bank projected. Still, the bank indicated that its most aggressive rate cuts are probably done. In previous statements, the bank has said that “further monetary stimulus is likely to be required in the near term.” But on Tuesday, the bank’s appeared less urgent to cut rates dramatically right away. “Some further monetary stimulus will likely be required to achieve the inflation target over the medium term,” the statement said, adding that any more rate cuts would depend on how the global slowdown and domestic demand in Canada unfold. Plus, the bank seems to have more confidence that its forecast will actually play out this time around. In March, the bank said there was a good chance that economic developments would turn out worse than it had projected in its base-case scenario. But now that their fears have been realized, the central bank thinks that things could just as easily turn out to be better than its now-downgraded forecast. “There are both upside and downside risks to the Bank’s new projection for inflation; these risks appear to be balanced,” the statement said. The bank noted that both total inflation and core inflation (which excludes the most volatile items such as energy and some types of food) are running lower than the bank’s target of two per cent. A weaker economy will keep inflation below the target through this year and next, moving back to the target in 2010. But it’s not all gloomy for the Canadian economy. Domestic demand – which measures economic activity within Canada’s borders but excludes trade – is strong, the bank said. Firm commodity prices, strong employment and interest-rate cuts should maintain that strength, the bank said. “This [is] the second straight half-point chop, marking the most aggressive course of rate chopping since 9/11 and the 2001 downturn,” noted Sal Guatieri, economist at BMO Nesbitt Burns. “While it’s far too early (and unfair) to label Governor Carney a ‘dove’, another half-point cut [goes] some ways to bolstering his reputation as a bold policy maker.”