Bank of Canada Pulls Out All the Stops
The Bank of Canada surprised most investors by cutting its main policy rate to only 0.25 percent, and it committed to keep it there until the middle of next year. Today's developments reinforce our views that the Canadian dollar will depreciate further in the months ahead.
Bank Unexpectedly Reduced its Policy Rate to 0.25 Percent
At its regularly scheduled policy meeting today, the Bank of Canada (BoC) surprised most investors by reducing its main policy rate from 0.50 percent to 0.25 percent, bringing the total amount of easing since December 2007 to 425 bps (see top chart). The BoC said that the rate is now effectively at its lower bound, which means that the rate won't be cut further. The BoC also made the unusual step of announcing that the rate likely will be held at 0.25 percent through the second quarter of 2010. The BoC committed to keeping its policy rate extraordinary low in order to pull down longer term interest rates, and its efforts bore some fruit. In the immediate aftermath of the announcement, yields on Canadian government bonds declined about 10 bps or so.
Like most major economies, Canada has slipped into a deep recession. As shown in the middle chart, real GDP declined at an annualized rate of 3.4 percent in the fourth quarter and available monthly indicators suggest that the economy continued to contract sharply in the first quarter. Indeed, the BoC said that "the recession in Canada will be deeper than anticipated, with the economy projected to contract by 3.0 percent in 2009." It went on to project that the recovery will "be delayed until the fourth quarter" and that the recovery will "be more gradual." The BoC projects that real GDP will grow 2.5 percent in 2010. Although our forecast for 2009 is very much in line with the BoC's outlook, we expect the economy will grow only 2 percent next year, slightly less than the BoC's projection.
With its main policy rate at the "lower bound," has the BoC run out of "ammunition"? No. As other major central banks have made abundantly clear recently, the BoC could embark upon a course of "unconventional" policies, including purchases of private sector assets and/or government bonds. Indeed, the BoC said that it will outline a framework on April 23 for further steps.
Further Weakness Ahead for the Loonie
The Canadian dollar, which has been trading in a fairly narrow range versus the U.S. dollar over the past few weeks, depreciated on the news (see bottom chart). Our forecast has called for renewed loonie depreciation in the months ahead, and today's developments reinforce our views. We believe that the exchange rate will make a run at its recent high (1.30 loonies per U.S. dollar) as sluggish global GDP growth keeps commodity prices depressed and as the Canadian economy remains in recession. Once growth - both globally and in Canada - begins to strengthen, the Canadian dollar should appreciate. Signs of stronger global growth probably won't begin to appear until late this year, however.
Wachovia Corporation
http://www.wachovia.com
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