Tuesday, August 25, 2015

Bank of Canada cuts rates again

The Bank of Canada cut its key interest rate by 1/4 percentage point to 0.5 percent, saying an unexpected economic contraction throughout the first half of the year had added to excess capacity and put downward pressure on inflation.

"Additional monetary stimulus is required at this time to help return the economy to full capacity and inflation sustainably to target," the central bank said in its interest rate decision accompanying its quarterly Monetary Policy Report.

Bank of Canada Governor Stephen Poloz's expectation of a recovery by now from the oil price crash proved to be far too optimistic, with the economy projected to have shrunk at an annualized 0.5 percent in the second quarter instead of growing by 1.8 percent as he had projected in April.

The bank did not use the word "recession" but the projection of negative growth in the first and second quarters met the most widely accepted definition of recession.
Excess capacity therefore grew significantly in the first half and would continue to do so in the third quarter even with expected economic growth of 1.5 percent. The bank pushed back to the first half of 2017 from the end of 2016 its projection of when full capacity would be reached and inflation would return to the 2 percent target.

The bank acknowledged elevated vulnerabilities from a hot housing market in Toronto and Vancouver and from rising household debt - a key factor that had had some economists calling for no rate cut - but said the Canadian economy was undergoing "a significant and complex adjustment" and required additional stimulus.

Analysts predict lower rates for 2 years

Reacting the Bank of Canada’s cut in interest rates many economists are predicting they will have to stay low for some time. While talk of cheaper mortgages may be in focus for homeowners and buyers the wider economic picture painted by the BoC is one of sluggish growth for Canada this year. Two quarters of negative growth (0.6 per cent in Q1 and 0.5 per cent in Q2) means a technical recession and the bank cut its expectation for this year to just above 1 per cent with next year and 2.5 per cent in 2016 and 2017. That contrasts with growth in the global economy of 3 per cent for this year and 3.5 per cent in the following two years. Additionally Fed chair Janet Yellen said Wednesday that the US economy is on target for a rise in interest rates.

The cut in interest rates has already hit the loonie, although that should help exports which are a key part of the plan to boost the economy. Some analysts are skeptical as to whether Canada can achieve even the downgraded GDP forecasts and are calling for interest rates to stay low, and perhaps go lower, during the next two years.

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