OTTAWA (Reuters) - The Bank of Canada cut its main interest rate to a record low on Tuesday and signaled for the first time that it may take extra steps to pump money into a system that remains stubbornly short of credit.
The central bank reduced its key overnight rate by a half point to 0.5 percent, as expected, for a cumulative reduction of 400 basis points since December 2007.
As the rate approaches zero, the bank began preparing markets for its next step, which could involve buying securities in the market to drive down longer-term interest rates and help banks expand their lending. This is known as quantitative easing.
It also did not close the door to an additional rate cut to 0.25 percent.
“Given the low level of the target for the overnight rate, the bank is refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing,” it said in a statement.
But the bank said it would not outline the framework for any such action until after its April 23 Monetary Policy Report, two days after its next scheduled rate decision.
“It’s sort of the nuclear option,” said Eric Lascelles chief economics and rates strategist at TD Securities.
“They refuse to rule out the possibility of more rate cutting and they seem to be very seriously thinking about quantitative easing ... it suggests the Bank of Canada is very serious about this situation and it recognizes it’s probably been a little too optimistic recently in terms of the outlook,” he said.
The Canadian dollar fell after the announcement and at 10:10 a.m. (1510 GMT) was at C$1.2896 to the U.S. dollar, or 77.54 U.S. cents, down from C$1.2845, or 77.86 U.S. cents, earlier in the day. The currency later rebounded to close at C$1.2911 to the U.S. dollar, or 77.45 U.S. cents, virtually flat with Monday’s close of C$1.2914 to the U.S. dollar, or 77.44 U.S. cents.
The Bank of Canada, like other central banks, is running out of ammunition to tackle the deepening recession as its benchmark rate approaches zero.
Governor Mark Carney said in January that the bank had a contingency plan in place, if required, and that it has studied steps taken by the U.S. Federal Reserve and in Japan, and their applicability to Canada.
Finance Minister Jim Flaherty said he and Carney were working closely to co-ordinate their next steps.
“There are other things they can do,” Flaherty told reporters. “We have to make sure that the steps, in terms of the additional steps, are well co-ordinated between the Bank of Canada and the government of Canada,” he said.
The bank said its key overnight rate “can be expected to remain at this level or lower at least until there are clear signs that excess supply in the economy is being taken up.”
The country’s major commercial banks moved in lock-step with the central bank, immediately cutting their prime rates by 50 basis points. The banks have taken heavy criticism for dawdling after past rate cuts or in some cases, failing to pass on the full rate reduction to their customers.
The central bank’s willingness to move beyond rate cuts to boost credit suggests it may be more worried about the Canadian economy than it previously let on, some analysts said.
“There had been a market expectation that the Bank of Canada had been reticent to go down that path,” said Derek Holt, economist at Scotia Capital.
Carney has emphasized that credit channels in Canada are healthier than in other major economies and that banks are generally in better shape.
“This is a bit of a step back from that argument,” Holt said.
The central bank acknowledged its latest projections for the economy now look optimistic in light of data showing 3.4 percent contraction in the fourth quarter.
It said the data points to a sharper decline in the economy and a larger output gap through the first half of 2009 than it projected in January. It expects core inflation to be lower than it previously estimated.
In January, the bank projected the economy would shrink at an annualized rate of 2.3 percent in the fourth quarter and 4.8 percent in the first quarter of this year, before returning to growth in the second half of the year.
It also saw core inflation, which excludes volatile items like gasoline, hitting a low of 1.1 percent in the fourth quarter.
The central bank said its aggressive rate cuts, plus government action to boost credit and growth, should begin to be felt in the second half of this year and build through 2010.
Canada’s recovery from recession should be quicker than that of other major economies, it said, but Canada still depends on the stabilization of the global financial system and a recovery of global growth.
Additional reporting by John McCrank, Jennifer Kwan and Ka Yan Ng in Toronto; editing by Peter Galloway and Rob Wilson