Bank of Canada surprises markets with rate drop

In a surprise move, Canada's central bank, the Bank of Canada, reduced the overnight lending rate by a quarter of a percentage point. The reason given was the threat to the economy of plunging oil prices.

The move by the Bank reduced the lending rate from 1.0 percent to 0.75 percent. The Bank governor Stephen Poloz said: "The drop in oil prices is unambiguously negative for the Canadian economy. Canada's income from oil exports will be reduced, and investment and employment in the energy sector are already being cut." While the overall effect of the drop in oil prices may be negative, the impact will vary from province to province. With its huge oil resources, Alberta will suffer a significant drop in income from royalties and a decline in economic activity in the oil patch, but other provinces with industries that use oil welcome the lower prices for inputs. Consumers, airlines, truckers, and cabbies will be cheering the downward trend in fuel prices.

 The Toronto Stock Market (TSX) was up almost 300 points not long after the announcement. No doubt the reduced rate will be expected to boost consumer demand and help raise the level of economic activity. Almost no economists had been predicting the rate cut at this time but more were suggesting it could happen in the future. 

The rate decrease, follows upon a recent downgrading of both global growth and Canadian growth in the World Economic Outlook for 2015 published by the IMF. The forecast reduced global growth rates by 0.3 percent to 3.5 percent in 2015 and 3.7 percent in 2016. Canada's growth was downgraded 0.1 percent to 2.3 percent for 2015 and even more 0.3 percent for 2016 to just 2.1 percent. The drop in oil prices by about 50 percent since September 2014 was cited as the main reason for the IMF downgrade. In June of last year oil was at $105 US a barrel but now is well below $50 a barrel. The Bank of Canada also downgraded its prediction for Canada's growth in 2015 from 2.4 percent to 2.1 percent even lower than the IMF prediction, although contrary to the IMF, it sees a rise to 2.4 percent in 2016. 

The Bank made its projection on the assumption that oil prices will average about $60 dollars a barrel over the next two years. Derek Burleton, an economist at TD Bank said: "It is a significant move. It does show the Bank of Canada is worried about the big drop in the price of oil ... and what kind of uncertainty that poses in the next few quarters. I don't think they are panicking but I do think they're concerned about some of the uncertainty the recent slump in the price of oil does create for the economy." BMO economist, Michael Gregory, said: "Today’s BoC rate cut smacks of being a one-time 'insurance' move but in his presser, Governor Poloz indicated that if the world changes again (adversely for Canada) the Bank could take out more insurance."  

The Bank predicts that the lower oil and energy prices will reduce inflation at least temporarily but over the projected two year period will again approach the target two percent level. The Canadian dollar, the loonie, is trending much lower. BNN reports: Charles St-Arnaud, senior economist at Nomura Securities International Inc., said the drop in crude will prompt the central bank to lower its growth forecast by 0.5 percent.The loonie depreciated 1.4 percent to $82.55 cents US in Toronto Tuesday, at one point touching its weakest level since April 2009. Nomura forecasts it will reach 80 cents US by the middle of the year. The lower loonie will help Canadian exporters but imports from the US will rise in price and the flow of shoppers across the border may slow considerably as the loonie declines in value against the US dollar.