OTTAWA (Reuters) - The Bank of Canada cut its key interest rate on Tuesday by a half-point to a 50-year low of 1 percent, and predicted a period of falling prices this year as an economic recession takes hold.
The central bank signaled that further rate cuts may be on the horizon, but said it would judge carefully “to what extent further monetary stimulus will be required”.
The latest move, which prompted a jump in the Canadian dollar, brings the overnight lending rate to a level comparable to that of July 1958, when the central bank used a different policy tool -- the bank rate.
Some analysts saw the bank’s message leaving the door wide open to rate cuts in March to combat the effects of the worst global financial crisis in 80 years. In new evidence Canada’s economy is in trouble, manufacturing sales plunged by a record 6.4 percent in November, data showed on Tuesday.
“Obviously we’re in a dire situation right now, the employment situation is deteriorating fast, consumer confidence is very low right now -- at historical lows,” said Martin Lefebvre, economist at Desjardins Securities.
But others suspected the bank was nearing the end of its easing cycle.
The outlook on rates is all the more uncertain as markets await the federal government’s budget on January 27, which Ottawa has said will contain a large stimulus plan. Both Canada’s and President Barack Obama’s emergency spending plans will affect the speed and timing of Canada’s recovery, analysts said.
“The path for the bank will be partly determined by what’s in next week’s budget but frankly how financial markets fare in coming weeks and months,” said Doug Porter, deputy chief economist at BMO Capital Markets.
Eight of Canada’s 12 primary securities dealers, surveyed by Reuters after the bank’s rate cut on Tuesday, forecast it would cut the rate again in March, with two calling for a 25-point cut and six calling for a 50-point cut. Four predicted no change to rates in March.
Ten expected no rate change in April.
The Canadian dollar firmed after the rate decision but at C$1.2664 to the U.S. currency, or 78.96 U.S. cents, in afternoon trade it was still down from C$1.2547, or 79.70 U.S. cents, on Monday.
One reason the bank may feel comfortable cutting rates further, after easing by 350 basis points since December 2007, was its prediction on Tuesday that the overall inflation rate would drop to below zero in the second and third quarters of this year for the first time since 1994.
It also added new language on the importance of “low, stable and predictable inflation”, which was absent from its December statement.
But Bank of Canada Governor Mark Carney is likely to reject the idea of “deflation” in Canada in a speech next week because the falling prices are of limited duration and caused by the year-on-year effect of much lower energy prices.
Core inflation, which excludes volatile items such as gasoline and is considered the best gauge of underlying price trends, is expected to bottom at 1.1 percent in the fourth quarter.
The bank sees both core and overall inflation rates creeping back up to its 2 percent target in the first half of 2011. More details on the bank’s thinking will come on Thursday in its Monetary Policy Report.
The Bank of Canada, like its peers in other countries, is scaling back economic growth estimates and said the global outlook has deteriorated since last month.
A recession in Canada will last through mid-2009, with the economy shrinking 1.2 percent on average this year before rebounding with 3.8 percent growth in 2010, the bank predicted.
Globally, the economic recovery will require that the financial system be stabilized first. Extraordinary measures taken by governments and central bankers were starting to gain traction but the bank said it would take “some time” for conditions to normalize.
Canada’s commercial banks were quick to follow through on the central bank’s rate move with cuts to their own prime lending rates. Bank of Montreal lowered its rate to 3 percent within minutes of the central bank’s announcement, followed by Toronto Dominion Bank, Royal Bank of Canada and Bank of Nova Scotia.
Additional reporting by Natalie Armstrong in Toronto; editing by Peter Galloway