The Bank of Canada reduced its benchmark interest rate for a second time this year as the damage from lower oil prices shrank the economy in the first half and leaves a full recovery nearly two years away.
When the Bank of Canada unexpectedly cut the rate in January by a quarter of a percentage point, the big banks cut their prime rates by 0.15 – but only after a week of hand-wringing about what to do.
Wednesday’s decision marks the second time the Bank of Canada has cut its key interest rate this year.
But Soper says the second consecutive rate cut could also reduce consumer confidence and temper home sales to some extent, thus reducing the impact on consumer borrowing.
The overnight rate is now at 0.50% bringing it closer to the USA and UK interest rate ensuring any yield advantage that has in the past propped up the CAD against GBP and United States dollars has now been eroded further. Recent evidence suggests a pickup in activity and rising capacity pressures among manufacturers, particularly those exporters that are most sensitive to movements in the Canadian dollar. The takeaway here is that it will take another significant disappointment in the economy to get them to cut further, although the market has hastily priced in another half chance of yet another cut. “Growth in Canada is projected to resume in the third quarter (of 2015) and begin to exceed potential again in the fourth quarter”, reads the report.
In what was seen as an absolute toss-up, the bank came down on the side of the rate cutters owing to the deep cut in their growth estimate for this year.
But despite a plunge in the value of the Canadian dollar and a strengthening US economy, exports have yet to pick up. Casting aside concerns about a fire-breathing housing market, a Canadian dollar testing decade-lows, and core CPI consistently above 2 per cent, the bank is more focused on the hit to growth from the oil shock and the “puzzling” weakness in the non-energy side of the economy. Low prices for oil and other commodities as well as faltering global economic growth and a decline in Canadian business investment have led to the Bank of Canada to downgrade Canadian GDP for 2015 to 1.1% down from the 1.9% forecast just 3 months ago. So, the Bank sees the underlying trend in inflation is about 1.5% to 1.7%. He had characterized his earlier January rate cut as “insurance”. The Bank anticipates that the economy will return to full capacity and inflation to 2 per cent on a sustained basis in the first half of 2017. As the economy is expected to recover, bond yields are expected to move higher and mortgage rates will follow, which will help cool off the housing market.