Lowest Rates ever

The Bank of Canada cut its key overnight interest rate 50 basis points to 0.5 per cent, the lowest level ever

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OTTAWA - The Bank of Canada has cut a key short-term interest rate about as low as it can go in what is becoming a frantic effort to spark recovery from a recession it admits it has misjudged in terms of both duration and seriousness.

The central bank did what virtually every private sector economist advised it to do Tuesday morning, slashing the trend-setting overnight rate to 0.5 per cent, uncharted territory.

But bank governor Mark Carney, who was criticized for being overly rosy in his outlook for the economy in January, now says that even at such unheard-of lows, the stimulus provided by traditional monetary policy is likely not enough.

And he said the bank now sees recovery coming later than it had projected, possibly in early 2010.

"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," Carney wrote in a statement of his rate decision.

The central banker does not give example of specific measures, but the language implies he is considering buying back government bonds and other forms of credit from chartered banks in order to provide more liquidity in money markets.

Canada's major banks appeared ready to play ball with Carney: shortly after the announcement, Royal Bank (TSX:RY), Bank of Montreal (TSX:BMO) and CIBC (TSX:CM) announced that they would cut their prime rates in step with the central bank.

The reference to non-traditional monetary measures confirms that Carney knows he has exhausted interest rate cuts as a means of stimulating the economy out of a deepening and increasingly stubborn recession.

There is only limited advantage in taking rates to zero - something few economists counsel. As well, the central bank has already slashed the overnight rate from 4.5 per cent 15 months ago to 0.5 per cent with limited impact.

As former Conservative cabinet minister and economist Doug Peters wrote last week: "Interest rates that count, such as interbank lending rates, mortgage lending rates, bank commercial lending rates, are all unusually high, especially considering that inflation is also very close to zero."

The other surprise is that although Carney said recently he is unlikely to revise his controversial January forecast until the next Monetary Policy Report in late April, he does just that in the brief statement.

"The outlook for the global economy has continued to deteriorate since the bank's January... update, with weaker-than-expected activity in major economies."

"National accounts date for the fourth quarter of 2008 and other indicators of aggregate demand point to a sharper decline in Canadian economic activity and a larger output gap through the first half of 2009 than projected in January."

Carney said potential delays in stabilizing the global financial system, along with low consumer confidence and larger hit on household wealth, "could mean that the output gap will not begin to close until early 2010."

In January, Carney had forecast the economy to start growing by an annualized two per cent in the third quarter of this year, and to record an average growth of 3.8 per cent next year.

Tuesday's statement does not officially alter the forecast, but strongly implies that both this year's 1.2 per cent contraction will be worse and that the recession may last until next year.

On Monday, Statistics Canada reported that Canada's gross domestic product had retreated by 3.4 per cent - more than the bank's expectation of a 2.3 per cent fall-back - and economists were for the first time calling Carney's prediction of a whopping 4.8 per cent contraction during this first quarter of 2009 optimistic.

Carney also forecast that inflation will likely be lower than expected this year.

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