January 23, 2008 / 12:38 AM / 10 years ago

Bank of Canada opts for mild rate cut despite Fed

<p>Bank of Canada Governor David Dodge leaves his office for a news conference in Ottawa October 18, 2007. The Bank of Canada cut its key overnight interest rate by a quarter-point to 4 percent on Tuesday, as expected, and said further cuts are likely to be needed to protect the economy from the worsening U.S. housing crisis. REUTERS/Chris Wattie</p>

OTTAWA (Reuters) - The Bank of Canada held back in the face of an aggressive interest rate cut by the U.S. Federal Reserve on Tuesday, shaving just a quarter-point off its own key rate, but it signaled more cuts to come as U.S. recession worries spiral.

In a regularly scheduled announcement, the central bank lowered its overnight lending rate to 4 percent from 4.25 percent. It was the bank’s second straight quarter-point cut as it seeks to protect the Canadian economy from the severe slowdown or even recession that faces Canada’s top trading partner.

The move came shortly after the Fed slashed its federal funds rate by 75 basis points to 3.5 percent. It disappointed a growing number of market players who are calling for a bolder rate cut by Canada to match the Fed.

“The Bank of Canada is clearly stubborn, not wanting to cut by more than 25 basis points and I think the market is quite disappointed,” said Eric Lascelles, chief economics and rates strategist at TD Securities.

Ted Carmichael, chief economist at JP Morgan Canada, said the bank “did what was expected a week ago and hasn’t reacted whatsoever to developments in financial markets in the past week.”

The Bank of Canada, which prepared its rate announcement on Monday, opted not to alter its decision at the last minute in reaction to the Fed move.

While warning that Canada’s exports will be hit by the U.S. slowdown, the bank emphasized that high commodity prices will continue to help keep Canada’s economy buoyant.

“Despite tighter credit conditions, domestic demand is projected to remain strong,” the bank said in its statement.

Retail sales for November rose by a stronger-than-expected 0.7 percent, new data showed on Tuesday.

However, the bank left the door wide open to future rate cuts. “Further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to return inflation to target over the medium term.”

Given the massive sell off in world stock markets and the quickly-worsening outlook for the United States, Canada’s central bank might consider cutting rates in between scheduled announcement dates, some analysts said.

The Toronto stock index plunged 4.75 percent on Monday in its biggest drop in more than seven years, but turned higher on Tuesday.

The bank has only made a surprise rate move once since adopting a fixed schedule for rate announcements in November 2000 -- a 50 basis point cut six days after the September 11, 2001 attacks in the United States.

DODGE‘S LAST HURRAH

The rate decision was the last under Governor David Dodge, who hands the baton to Mark Carney on February 1, and some analysts believe the symbolism weighed into the bank’s decision.

“This is Dodge’s last hurrah and he may have wished to pass things along in a somewhat conservative fashion and not commit on Carney’s behalf without Carney really getting to take the reins here,” Lascelles said.

Hinting at revised projections scheduled for release on Thursday, the central bank said its 2008 outlook for the U.S. economy is now “significantly weaker” than the 2.1 percent it forecast in October. The Canadian economy will move into a situation of excess supply in the second quarter of this year, it said.

However, it said the economy is still running at above capacity despite slowing in the fourth quarter.

The bank’s quarterly business survey showed the portion of firms with some degree of difficulty meeting increased demand shot up to a record high of 60 percent in the fourth quarter, a sign of inflationary pressure.

Inflation projections are now being revised downward, with both total and core consumer inflation now expected to dip below 1.5 percent by mid-2008 before returning to the bank’s 2 percent target by the end of 2009.

Reporting by Louise Egan; Editing by Peter Galloway

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