Bank of Canada Cuts Policy Rate by Another 50 Basis Points to 1%

The Bank of Canada cut the overnight rate by an as-expected 50 basis points to 1% and reiterated that the global economic backdrop "has deteriorated." The Bank cut the forecast for Canadian economic growth and now expects the economy to contract by 1.2% in 2009, a marked adjustment to its October forecast for the economy to grow by 0.6% this year. The implications of the softer economic projection for inflation are that the core inflation rate will bottom at 1.1% in the fourth quarter, lower than the previous assumption. Combined with the sharp declines in energy prices, the headline rate is likely to "dip below zero for two quarters in 2009" the Bank said.

The Bank highlighted that the global policy response has been "bold" and said there are "signs that these extraordinary measures are starting to gain traction" while acknowledging that conditions remain far from normal. While Canada's current economic data are likely to remain dismal with the economy "now in recession" the tone of the statement, once again, hints of some confidence that these policy initiatives will bear fruit.

The Bank upgraded the forecast for 2010 and now looks for the economy to grow by 3.8%, up from 3.4% projected in October. However, it restated that it will "monitor carefully economic and financial developments in judging to what extent further monetary stimulus will be required to achieve the 2 per cent inflation target over the medium term", thus leaving the door open to further rate cuts if the economy underperforms the Bank’s near-term expectations.

Canada's economy is facing a myriad of negative factors with the global recession weighing on commodity prices, the U.S. downturn deepening and still-strained credit conditions. All told, Canada's economy held up remarkably well in the third quarter, but fourth-quarter indicators show that these factors are taking a hit and RBC forecasts that the economy contracted at a 2.5% annualized rate in the fourth quarter of 2008, with another hefty decline expected in the first quarter of 2009. Beyond that, we expect the combination of historically low interest rates, past and upcoming fiscal stimulus and the weaker Canadian dollar to limit the extent of the weakening, with modest positive growth rates forecast for the second half of the year. Should these factors prove insufficient and a more protracted downturn ensues, further interest rate cuts cannot be ruled out in the months ahead.

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.