March 4, 2008 / 2:28 PM / 10 years ago

Bank of Canada slashes rates on gloomy U.S. view

OTTAWA (Reuters) - In its first interest rate decision under new Governor Mark Carney, the Bank of Canada sounded a gloomy warning on the U.S. economy on Tuesday by slashing its key rate by a half point, the biggest cut since 2001, and signaling more to come.

<p>The Governor of the Bank of Canada, Mark Carney, speaks to the British Columbia Chamber of Commerce and the Business Council for British Columbia in Vancouver British Columbia, February 18, 2008. REUTERS/Lyle Stafford</p>

The bank reduced its overnight lending rate to 3.50 percent, bringing Canada’s cumulative rate cuts since December to one percentage point and narrowing the gap with the U.S. Federal Reserve’s 3-percent rate.

In a sign that Carney is more troubled by the spillover effects of the U.S. housing crisis than his predecessor David Dodge, the bank said its outlook for the U.S. economy had worsened since January, outweighing any potential inflationary pressure from strong domestic spending.

“There are clear signs that the U.S. economy is likely to experience a deeper and more prolonged slowdown than had been projected in January,” the bank said in a statement.

“These developments suggest that important downside risks to Canada’s economic outlook that were identified in the MPRU (January 24 Monetary Policy Report Update) are materializing and, in some respects, intensifying.”

Carney assumed the job of central bank chief on February 1.

“It’s a pretty dovish statement and I think Carney has clearly put his mark on this one and he is somewhat more dovish than Dodge was in my view,” said Eric Lascelles, chief economics and rates strategist at TD Securities.

The bank’s statement repeated a line from its January 22 rate cut that said “further monetary stimulus is likely required in the near term.”

“I don’t think you can necessarily just assume they’re going to go once more, or by just 25 basis points further, with a statement like that, so I think you need to start to cite risks of additional easing of above and beyond the conventional view right now,” Lascelles said.

The last time the Bank of Canada cut rates by 50 basis points was in the period following the September 11, 2001, attacks in the United States. From September to November that year, it lopped 175 basis points off its key rate.

Commercial banks took longer than usual in following up by lowering their prime lending rates, with TD Canada Trust (TD.TO) making the first move over five hours after the central bank’s announcement. TD lowered its prime rate by 50 basis points to 5.25 percent. The Canadian Imperial Bank of Commerce (CM.TO) and RBC Royal Bank (RY.TO) did the same shortly afterwards and others were expected to follow.

SIGNIFICANT SPILLOVER

Most primary securities dealers surveyed by Reuters last Friday had anticipated Tuesday’s 50 basis-point cut. A majority expected additional 25-point cuts in April and June.

The Canadian dollar fell against the U.S. dollar after the rate move, and was trading at around US$1.0070, valuing a U.S. dollar at 99.30 Canadian cents. That was down from US$1.0116, which had put a U.S. dollar at 98.85 Canadian cents.

The collapse of the U.S. housing market is adversely affecting other sectors of the U.S. economy and causing a further tightening of credit, the bank said. This deterioration should have “significant spillover effects” on the global economy, it said.

Canada sells three-quarters of its exports to the U.S. market, making it highly vulnerable to drops in U.S. demand.

In fact, sagging exports were the culprit behind Monday’s report of disappointing fourth-quarter growth of 0.8 percent on an annualized basis, down from 3 percent in the third quarter and below the central bank’s projection of 1.5 percent.

However, domestic demand remains strong, and growth and inflation have been broadly in line with expectations, leading the bank to judge that the economy was running at above capacity at the end of 2007.

Consumer spending grew at an annual rate of 7.4 percent in the fourth quarter, as a commodity boom boosted personal income.

Additional reporting by Frank Pingue and John McCrank in Toronto; Editing by Renato Andrade

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