BOC Reduced Interest Rate to 0.25% - The End of Conventional Monetary Policy But The Beginning Of QE

The Bank of Canada cut interest rate by 25 bps to 0.25%, the lowest since the central bank was founded in 1934, and announced that it will be kept at least until 2Q10 as inflation will drop below 2% target for an extended period of time. Since December 2007, BOC has lowered its policy rate by 425 bps.

The central bank also revised down economic forecast to a contraction of -3% in 2009 and anticipated recovery will be delayed to 4Q09 and at a more gradual pace. In 2010 and 2011, GDP growths are projected be +2.5% and +4.7%, respectively, while production capacity will be reached in the third quarter of 2011.

Concerning inflation, BOC forecast core inflation to 'diminish through 2009, gradually returning to the 2% target in the third quarter of 2011 as aggregate supply and demand return to balance. Total CPI inflation is expected to trough at -0.8% in the third quarter of 2009 and return to target in the third quarter of 2011'.

In order to maintain interest rate at 0.25%, BOC will 'roll over a portion of its existing stock of one- and three-month term Purchase and Resale Agreements (PRAs) into six- and twelve-month terms at minimum and maximum bid rates that correspond to the target rate and the Bank Rate, respectively'.

To keep its policy rate unchanged at the current 'effective lower bound' for at least a year implied BOC is ready to implement unconventional easing measures which will be outlined in the Bank's Monetary Policy Report on 23 April.

Although CAD rose against the dollar after the announcement, we believe near-term risk is seen in CAD as aggressive QE would inevitably increase money supply which is generally negative for the nation's currency. However, long-term impact is yet to know as it also depends on the easing policies adopted by other countries.