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Interest Rate Trends -March Article

Bank of Canada cuts interest rates again in March
Overnight rate drops to half of one per cent

The Bank of Canada lowered its benchmark overnight lending rate by half of a percentage point to 0.5 per cent at its setting on March 3rd, 2009. The trend-setting Bank rate, which is set 0.25 percentage points above the overnight lending rate, declined to a record low of 0.75 per cent.

The Bank acknowledged the global economy has continued to deteriorate since it last lowered rates in January 2009. "The nature of the U.S. recession, with very weak auto and housing sectors, is particularly challenging for Canada," said the Bank.

The Bank has repeatedly lowered its interest rate to support economic growth. Since December 2007, the Bank has cut its overnight lending rate by a total of four per cent.

"The Canadian economy is still widely expected to begin growing in the second half of 2009, as government spending and easier credit begins to lift economic growth," said CREA Chief Economist Gregory Klump. "However, the Bank acknowledged that the decline in economic activity in the first half of 2009 could be sharper than forecast in January."

The Bank reiterated its expectation that "the effects of the recent aggressive monetary and fiscal policy actions in Canada and other major economies will begin to be felt in the second half of this year and will build through 2010. Once the global financial system stabilizes and global growth recovers, the underlying strength of the Canadian economy and financial sector should ensure a more rapid recovery in Canada than in most other industrialized economies."

The Bank also hinted for the first time that the recession could be longer than is currently forecast, however. Noting that there could be potential delays in stabilizing the global financial system, which it considers a precondition for the global and Canadian economic recoveries, the Bank said: "The timely implementation of ambitious plans in some major countries to address toxic assets and recapitalize financial institutions will be critical."

As such, the forecast for economic growth in 2009 in the next Monetary Policy Report, which is slated for release in late April, will likely be revised further down. It remains to be seen whether the recovery expected by the Bank will be pushed out beyond the current forecast, in the second half of 2009.

"The Bank’s current forecast for economic growth and inflation, and likely further downward revisions, means it won’t raise interest rates anytime this year, but credit conditions have tightened, which will mute the benefit of the Bank of Canada’s recent interest rate cuts for consumers, business, and the economy," said Klump.

When the Bank cut its overnight lending rate by 0.75 percentage points in December 2008, the prime rate fell by just 0.5 percentage points. This raised the spread to 1.75 per cent from 1.5 per cent, where it had stood for over a decade. This time, however, it appears that the Chartered Banks will cut their prime rates in step with the central bank.

Echoing previous messages about the potential for additional interest rate cuts when it next meets to set its interest rate policy, the Bank also said it "will continue to monitor carefully economic and financial developments in judging to what extent further monetary stimulus will be required to achieve the two per cent inflation target over the medium term."

The Bank also added: "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." The framework for the possible use of such measures would be outlined in the April Monetary Policy Report. In general, quantitative easing is when the Bank uses newly created money to buy assets from Chartered Banks in order to raise the money supply and stimulate the economy.

When the Bank cut interest rates on March 3rd, the advertised five-year conventional mortgage rate stood at 5.79 per cent. This is down 1.5 per cent from one year earlier, and 0.96 per cent below where it stood when the Bank made its previous interest rate announcement on January 20th, 2009.

The ongoing credit crunch has led mortgage lenders to reduce discounts on advertised mortgage interest rates, and in some cases these have been completely eliminated.

"Sales activity and prices will decline this year, as many buyers hunker down and put off buying decisions during the economic recession," said Klump. "Housing market prospects will improve in 2010 in tandem with a rebound in economic growth." (CREA 03/03/2009)
Posted: Friday, April 10, 2009 11:47 AM by Shannon Babcock Prec

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