Bank of Canada makes shock rate cut on oil concerns

Wed Jan 21, 2015 12:23pm EST
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By Randall Palmer and Leah Schnurr

OTTAWA (Reuters) - In a shock move, the Bank of Canada cut its benchmark interest rate on Wednesday to counter the effects of cheaper oil on economic growth and inflation and help guard against the risks of a housing market downturn.

Ending the longest period of unchanged rates in Canada since 1950, the central bank cut its overnight rate to 0.75 percent from 1 percent, where it had been since September 2010, and it dramatically slashed its inflation and growth forecasts for the coming year.

Canada is the biggest foreign supplier of crude oil to the U.S. market.

"The considerably lower profile for oil prices will be unambiguously negative for the Canadian economy in 2015 and subsequent years," the central bank said in its quarterly Monetary Policy Report.

The cut caught markets by surprise and sent the Canadian dollar to a 5-1/2-year low against the greenback. The Toronto stock market's main index surged 1.5 percent.

"We didn't think things had deteriorated enough for the Bank of Canada to move as quickly as this," said Adam Cole, head of G10 FX strategy for RBC in London.

The bank acknowledged that household debt levels remained high and were expected to edge up in the near term, and signaled that it had to cut rates "to provide insurance" against the risks of financial instability and lower inflation.

Lower interest rates could exacerbate the ill effects of a hot housing market in Toronto and elsewhere, but the bank's move suggested it was more concerned that the oil price collapse might trigger a housing crash.   Continued...

A general view of the Bank of Canada building in Ottawa July 21, 2009.  REUTERS/Blair Gable