Bank of Canada Cuts Overnight Rate by 50 Basis Points

The Bank of Canada cut the overnight rate by 50 basis points to 3% citing the "sharp slowdown in the U.S. economy and ongoing dislocations in global financial markets" (with attendant tightening in credit conditions) and indications that "growth in the Canadian economy has also moderated."

While the statement still points to further easing the language is less definitive than in the March statement, suggesting that the Bank is shifting to a less aggressive stance. After a modest downgrade to the inflation forecasts, the Bank now views the risks as being balanced.

As usual, the Bank previewed the changes to their economic forecasts that will be presented in the Monetary Policy Report on Thursday. While policymakers still characterize Canada's domestic economy as buoyant, supported by the improved terms of trade and strong labour market, worries about the impact of the tightening in credit conditions and the flagging U.S. economy on the outlook for exports resulted in downgrades to Canada's 2008 and 2009 GDP forecasts. The Bank downgraded their forecast for 2008 growth to 1.4% from 1.8% in January with 2009 GDP growth forecast at 2.4%, below January's 2.8% projection. The Bank expects the economy to reaccelerate in 2010 with GDP growth projected at 3.3%.

We expect that the detailed table contained in Thursday's Report will show the Bank increased the anticipated drag from net exports on 2008 GDP growth from the 1.4 percentage points forecast in the January Update. This would be in line with the statement that "the Bank is now projecting a deeper and more protracted slowdown in the US economy" which will continue to temper demand for Canadian exports. The Bank also expects the tightening in credit conditions to "moderate business investment and consumer spending."

Inflation has been tracking the Bank's forecast, with the all-items averaging 1.8% in the first quarter (versus the Bank's forecast of 1.7%) and the CPIX averaging 1.4%, bang on expectations. The prospect of weaker growth "should keep downward pressure on inflation through 2009. Both core and total inflation are projected to move up to 2% in 2010 as the economy moves back into balance." In their January statement, the Bank expected both the core and all items rates to move up to 2% by the end of 2009 with the March statement indicating the risks to the outlook were to the downside. This time, the Bank characterized the risks to the inflation outlook at being more balanced.

While the statement reiterated that "some further monetary stimulus will likely be required to achieve the inflation target" the Bank omitted "in the near term" in today's statement. This omission indicates that policymakers will be gauging the effects of the recent rate cuts on the economic outlook and, although the statement still leaves the door open to further downward adjustments in the policy rate, the degree of future easing is likely to be limited. We look for the Bank to lower the overnight rate in June to 2.75% and then look for policymakers to shift to the sidelines for the remainder of the year.

RBC Financial Group
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The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.