Canada cuts key rate

January 21, 2015 09:43 AM

The Bank of Canada unexpectedly cut its main interest rate by a quarter percentage point, saying the crude oil price shock will drag down inflation and weigh on everything from exports to business and consumer spending.

The bank cut its rate on overnight loans between commercial banks to 0.75 percent, a decision none of the 22 economists in a Bloomberg News survey predicted. The rate, which influences everything from car loans to mortgages, had been at 1 percent since September 2010, and the last cut was in April 2009.

“It’s a shocker,” Sal Guatieri, a senior economist at BMO Capital Markets in Toronto, said in a telephone interview. “It is an aggressive move. It speaks volumes about where the Bank of Canada sees the economy and inflation going.”

Policymakers are grappling with the impact of crude oil, Canada’s top export, falling to less than $50 a barrel from $107 this summer. The nation’s currency depreciated more than 2 cents against its U.S. counterpart on today’s rate decision, and two- year bond yields plunged 25 basis points to as low as 0.63 percent. Stocks climbed.


Downside Risks

“The oil price shock increases both downside risks to the inflation profile and financial stability risks,” the central bank said in the statement. Today’s rate cut is “intended to provide insurance against these risks” and support the adjustments needed to return the economy to full output.

The central bank also reduced its growth forecast for the first half of this year to a 1.5 percent annualized pace, from an October estimate of 2.4 percent. Inflation will slow to 0.3 percent in the second quarter, outside the central bank’s target range of 1 percent to 3 percent, the bank projected.

The latest forecasts assume benchmark crude prices at $60 a barrel, down from an October assumption of $85 barrel. Policy makers said there are near-term risks that prices will remain lower than $60, and if they persist around $50 then first-half growth could fall to 1.25 percent.


Projects Unprofitable

Oil and gas investment will probably drop by about 30 percent this year and be little changed in 2016, the bank said, adding growth in Canadian energy exports will slow to 1 percent from 6 percent in 2014. Crude oil prices mean “many projects” in Canada are now unprofitable, the central bank said.

“Given the magnitude of the shock to oil prices, there is an exceptional amount of uncertainty about the profile” for inflation, the bank said.

On the brighter side, the central bank said the lower oil price will boost global growth, in particular in the U.S., Canada’s largest trading partner. That should raise Canada’s 2016 growth rate to 2.4 percent, higher than the October forecast of 2.3 percent, the bank said.

Household debt remains “elevated” and there are risks that the Alberta housing downturn may spread to other regions, although a “soft-landing” in housing remains the most-likely outcome, the bank said.

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