Big 5 drop prime half a percentage point after Bank of Canada pares trendsetting rate to record low 1%
Jan 21, 2009
The Bank of Canada slashed its key interest rate yesterday by half a percentage point to 1 per cent, the lowest in 50 years, and delivered a gloomy assessment of the country's economic prospects for this year.
The drop in the overnight rate – the rate at which major financial institutions lend short-term money among themselves – is the latest move in a campaign of monetary easing aimed at reviving the country's flagging economy. The central bank has chopped its key rate by 3.5 percentage points since December 2007 and the target for the overnight rate now stands below the 1.12 per cent level the central bank set in 1958, although the two rates are not directly comparable.
"The outlook for the global economy has deteriorated since the bank's December interest rate announcement, with the intensifying financial crisis spilling over into real economic activity," the central bank said in a statement accompanying yesterday's rate cut. "Heightened uncertainty is undermining business and household confidence worldwide and further eroding domestic demand."
The Bank of Montreal, the Toronto Dominion Bank, the Canadian Imperial Bank of Commerce, the Royal Bank of Canada and the Bank of Nova Scotia almost immediately followed the Bank of Canada's lead, dropping their prime rates by half a percentage point to 3 per cent. Some of the banks also cut mortgage rates.
Chartered banks were heavily criticized last month for failing to match a 75-basis-point cut in the overnight rate, instead cutting their prime rates from 4 per cent to 3.5 per cent. Consumer advocates argued that the banks should have passed along the full effect of the central bank's rate cut to consumers in light of taxpayer-funded programs the federal government has provided to financial institutions to boost their lending capacity.
TD Bank chief economist Don Drummond said yesterday's prime rate cuts were driven by recent drops in the banks' short-term cost of funds, but said medium- and longer-term funds costs still pose "a major problem for the pricing of mortgages and other loans."
In its statement, the central bank said Canada's economy will contract through the first half of this year, and forecast that real GDP will drop by 1.2 per cent in 2009 on an annual average basis, a sharp revision to its October forecast for growth of 0.6 per cent this year. The central bank also said that core inflation, which excludes volatile components such as produce and gasoline, will dip to 1.1 per cent in the fourth quarter of 2009, while total inflation will fall below zero for two quarters this year, reflecting plummeting energy prices.
The bank said that "bold and concerted policy actions" by governments and central banks are "starting to gain traction, although it will take some time for financial conditions to normalize." Leaving the door open to further rate cuts, it said it will "continue to monitor carefully economic and financial developments in judging to what extent further monetary policy will be required."
But the bank also suggested it expects a sharper recovery than previously anticipated, forecasting real GDP to grow by 3.8 per cent in 2010, up from the 3.4 per cent that it had projected in October. It also sees inflation returning to the bank's 2 per cent target in the first half of 2011 "as the economy returns to potential."
While yesterday's rate cut was in line with expectations, several economists suggested the central bank's forecast for next year is too rosy. Some also warned that the Bank of Canada is running out of room to cut.
Royal Bank assistant chief economist Paul Ferley noted the central bank "has indicated preparedness to ease further if necessary," raising the possibility of further rate cuts, but said it "may increasingly opt for measures similar to the (U.S. Federal Reserve) where they identify pressures in particular financial markets and act to inject liquidity specific to those markets." The U.S. central bank has already effectively dropped its key rate to zero.
Dale Orr, chief economist for Canada at IHS-Global Insight, said the bank's forecast will put pressure on the federal government "to get the spending going quickly and to get it stopped about mid-2011" to avoid inflation. Finance Minister Jim Flaherty is expected to introduce a major stimulus package in next Tuesday's budget.
But United Steelworkers economist Erin Weir argued the Bank of Canada should have made a much deeper rate cut