February 24, 2015 / 7:19 PM / in 2 years

Bank of Canada says January rate cut the right amount of 'insurance'

LONDON, Ontario (Reuters) - The Bank of Canada took out the right amount of "insurance" when it cut interest rates by one-quarter percentage point last month to protect the economy from the impact of cheaper oil, Governor Stephen Poloz said on Tuesday.

The rate move bought the central bank time to see how Canada's oil-exporting economy responds to a plunge in oil prices, Poloz said in the bank's last pronouncement before its next rate decision on March 4.

"At the time we made the cut, we thought it was approximately the right amount of insurance given what we saw," he told reporters, pointing out that the bank assumed a $60 a barrel price for Brent crude. Brent traded on Tuesday at $58.65.LCOc1

"That assumption's held up well so far, and so what that shows is that under those assumptions we get back to full capacity late 2016, and then inflation would be sustainably on target."

After the shock rate cut in January, markets began to assume there would be another one next week. But Deputy Governor Agathe Cote was careful last week to say there was "no predetermined path" for the policy rate.

By late Tuesday, the market's rate cut expectations had fallen to 70 percent from 74 percent before Poloz's remarks BOCWATCH. The Canadian dollar CAD=D3 strengthened to a session high of C$1.2486, or 80.09 U.S. cents, from C$1.2608, or 79.31 U.S. cents.

Poloz said the insurance taken out via the rate cut was against too-low inflation and financial instability spurred by high household debt. "The sudden drop in global oil prices has increased both risks," he said.

He said the rate cut gave the bank greater confidence of a return to full capacity and stable inflation by the end of 2016, instead of sometime in 2017. It will also cushion the decline in income and employment, as well as the rise in the debt-to-income ratio, caused by lower oil prices.

"We are in a very uncertain setting, and what we are trying to do is to manage the risks we face, not eliminate them," he said.

Negative effects of lower oil prices hit the economy right away, he said. Positive effects, including more exports due to a stronger U.S. economy and lower Canadian dollar, and more domestic consumption, will arrive only gradually and are of uncertain size.

Writing by Randall Palmer and David Ljunggren; editing by Andrew Hay and Peter Galloway

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