Bank of Canada shocker: key interest rate drops to 0.75% amid oil slump threat, The Province

This article appeared on The Province on January 21, 2015 by Andy Blatchford, The Canadian Press.

OTTAWA - The threat of sliding oil prices forced the Bank of Canada to drop its trend-setting interest rate Wednesday, a surprising move that revealed how the country's economic outlook soured in just a matter of months.

The central bank, which nudged its key rate down to 0.75 per cent from one per cent, said the rapid oil-price collapse has created many unknowns around economic growth in the oil-exporting nation.

Until the effects of oil's late-2014 tailspin started to trickle through, Canada appeared to be on the cusp of a promising post-recession rebound — and inching closer to a rate hike.

"The drop in oil prices is unambiguously negative for the Canadian economy," governor Stephen Poloz told a news conference after the bank made the announcement.

"We have an oil-price shock, which will reduce the income flowing into Canada and lead probably to some increase in unemployment overall."

The decision Wednesday marked the first time the rate budged at all since September 2010 when the central bank raised it by a quarter point to one per cent.

The Bank of Canada was widely expected to once again stand pat on its rate Wednesday, with most economists projecting an increase in late 2015 or early 2016.

The loonie dropped after the announcement by 1.12 cents US to 81.48 cents US — its lowest level since late April 2009, the last time the bank cut its overnight rate.

The central bank predicts the impact of falling oil prices to overshadow encouraging signs of economic life spotted outside the weakening energy sector, such as rising foreign demand, a boost in exports and job growth.

But Poloz insisted Wednesday he was still encouraged by ongoing improvements in the background, particularly in Canada's non-energy sector.

He also sought to ease potential fears stirred up over the cut. He was asked whether the move was a signal he was worried about the economy.

"That doesn't mean that there's a really bad thing, or a drastic thing, happening here," Poloz said of the rate reduction.

Poloz predicted Canada's fortunes to receive a boost from the combination of a weakened loonie and the ever-strengthening U.S. economy, a country expected to benefit from lower crude prices.

The rate decrease aims to soften the blow of cheaper crude by providing "insurance" against risks it poses to Canada's inflation and its financial stability.

The bank is counting on the rate cut to buffer the healing part of the economy from low oil long enough for businesses to invest in their operations using the cheap credit and, eventually, create jobs.

"We think that the positive trend is underneath the surface, that things are getting stronger," Poloz said.

"For us, it's a more a matter of re-positioning the economy in such a way that it fires on all cylinders."

On Wednesday, the bank reiterated its warning that Canadian households remained vulnerable to economic shocks due to near-record-high housing prices and debt.

This accumulation has been blamed on the extended period of an already-low interest rate of one per cent, which propelled consumer spending.


However, Bank of Canada senior deputy governor Carolyn Wilkins, who joined Poloz at Wednesday's news conference, didn't think an even-lower rate would lead to more debt.

She predicted the oil collapse would lead to a drop in employment, reducing the amount of disposable income available to Canadians and lowering consumption.

This combination, she added, is expected to ease the debt load, even with the rate drop.

The bank's concerns over the oil slump come as some Canadian industries reel from the sharp plunge in crude prices, which are down more than 55 per cent since June.

The Canadian Association of Petroleum Producers said Wednesday it expected oilpatch investment to total just $46 billion this year, down from $69 billion in 2014.

The decline in oil prices is also expected to shave billions of dollars from the bottom lines of federal and provincial governments.

Last week, the federal government took the rare step of delaying the budget until at least April, so it could assess the effect of tumbling crude.

In the monetary policy report Wednesday, the central bank predicted the country's headline inflation rate to temporarily dip to one per cent — below the bank's target range — before climbing back up to two per cent in the second half of the year.

The central bank also highlighted persistent problems in Canada's labour market, where it found long-term unemployment was still close to its "post-crisis peak."

It said average hours worked remained low and the proportion of people who could only find part-time work was still high.

The bank predicted the pace of Canada's economic growth — measured by the real gross domestic product — to slow to roughly 1.5 per cent in the first half of 2015 and for the output gap to widen.

It projected the Canadian economy to gather steam in the second half of the year, allowing real GDP growth to average 2.1 per cent in 2015 and 2.4 per cent in 2016.

The bank's estimates were based on oil prices of US$60 per barrel, which is higher than current prices that are below US$50. The report said if oil were to remain close to US$50, real GDP growth would dip to 1.25 per cent in the first half of 2015.

In its last monetary policy report — in October — the Bank of Canada predicted 2.4 per cent growth for 2015.

The Bank of Canada is scheduled to make its next interest-rate announcement March 4, while its next monetary policy report is due April 15.

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