Bank of Canada Slices Another 50 Basis Points off the Policy Rate; Contemplating Quantitative/Credit Easing
The Bank of Canada cut the overnight rate by 50 basis points to 0.5% largely in line with expectations with futures markets priced for 40 of the 50 basis-point slice. Highlighting the extraordinary conditions facing the Canadian and global economy, the Bank said it is "refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing", a more aggressive stance than most expected.
In the statement, the Bank acknowledged that Canada's economy was weaker than they expected and that core inflation rate is likely to be lower than in their January baseline forecast. As a result, the Bank lowered the policy rate and vowed to maintain it "at this level or lower" until the economy is growing sufficiently strong to close the output gap and thereby mitigate the downside risks to the inflation outlook.
The economy faltered badly in the fourth quarter of 2008 with real GDP dropping at a 3.4% annualized pace and January data providing little encouragement that the decline will be a one-off event. Although the Bank had warned of near-term weakness, it projected a decline in the fourth quarter of only 2.3% followed by a more pronounced 4.8% plummet in the first quarter of 2009.
Details of the fourth-quarter GDP report showed an unwanted build-up in inventories in late 2008, which, combined with the sharp deterioration in the labour market and housing activity in January, signals that downward pressures intensified going into 2009. The marked slowing in trajectory of the monthly GDP numbers (December fell at a whopping 1% rate) also augurs poorly for first-quarter growth. While this played to the script of the Bank of Canada's forecast, the miss on their fourth-quarter growth rate projection will leave the economy even more battered-and-bruised than they had anticipated and justifies their actions today.
Today's bold statement highlights that Bank's nervousness that the typical policy tools will not be sufficient to put the economy back on a solid growth path. The inclusion of the reference to quantitative and credit easing indicates that the Bank is keeping its options open as it works to nurse the economy back to health and that policymakers here are ready to follow the lead of the United States, the United Kingdom and others in moving to more innovative ways to attack the problems.
However, there remains a note of optimism in the statement as the Bank asserts that fiscal and monetary policy stimulus will support the economy in the second half of this year. Additionally, the Bank views Canada as being in a stronger position than most countries and forecasts a stronger rebound once the global economy stabilizes. Our base case view is that the amount of fiscal and monetary policy stimulus will return the economy's growth rate to the positive column later this year but, given the upheaval in the global economy, a shift to less-traditional measures cannot be ruled out if the economy fails to revive.
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.
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