Bank of Canada to Cut Rates Tuesday

October 20, 2008

The seventh of eight scheduled Bank of Canada interest rate policy announcements at 13:00 GMT on Tuesday will contain a target rate cut of at least 25 basis points and probably one of a half-percentage point to 2.0%.  In an unscheduled and coordinated move on October 8th, the Bank of Canada was one of seven central banks to cut rates, and the Bank of Canada is the first of them to be holding a follow-up scheduled reduction, so its action and statement of explanation will be combed carefully for clues to what might happen soon among all G7 central banks.

Prior to this month, the Bank of Canada had cut its overnight target rate by 25 basis points each in December and January and by 50 basis points apiece in March and April, but policy was kept steady at meetings held in June, July, and September in deference to above-target inflation.  Canadian real GDP fell 0.8% at a seasonally adjusted annualized rate in 1Q08 and grew just 0.3% saar in 2Q.  Both results were softer than Bank of Canada officials had assumed. The scheduled announcement on September 3rd had been less dovish than assumed, nevertheless, and officials then were not anticipating a return of CPI inflation to 2.0% until after mid-2009. Canada’s latest reported 12-month rates of total inflation are 3.5% on the CPI and 8.1% on the PPI.

The subsequent statement of October 8th was more sanguine about the outlook for inflation, declaring that “below-potential growth in aggregate demand through 2009, combined with a lower profile for commodity prices, will significantly ease inflation pressures in Canada. Inflation expectations remain well anchored.”  An additional follow-through reduction now of fifty basis points from Canada’s overnight target rate would still leave such 75-100 bps above U.S. rates, once the Fed eases later this month. Weakening U.S. data provide critical forward-looking information for Canada, which ships three-fourths of its exports to its southern neighbor.  In that regard, reported declines since the coordinated rate cut in U.S. retail sales and industrial production of 1.2% and 2.8% in September, plus the news of a record one-month deterioration in U.S. consumer confidence, provide more than enough justification for the Bank of Canada to ease again this month, rather than wait until its next policy announcement on December 9th.

In addition, Canada has reported some worrisome figures of its own. Manufacturing shipments and orders pulled back 3.7% and 1.1% in August.  New motor vehicle sales recorded a third straight decline of 2.3% m/m and were 4.1% lower than a year earlier.  Real non-residential construction fell 1.4% in 3Q08.  Consumer confidence feel from 85.8 in September to 73.9 in 3Q, worst in a generation, despite decent employment growth of 1.1% at an annualized rate in January-September.  Wholesale turnover fell 1.5% in August.

Several other developments since the coordinated rate cut in early October will need to be considered.  During the five calendar weeks between September 12th and Octobere 17th, Canada’s TSE-300 stock index plunged 25%.  Canadian voters elected the third minority government in four years last Tuesday.  Stephen Harper, leader of the Conservative Party and predisposed against a big supplementary fiscal stimulus and deficit spending of any sort, remains prime minister. Like many other central banks, the Bank of Canada has been engaged in activities to keep the Canadian financial system liquid in this period.  Commodity prices have softened, alleviating domestic inflationary pressures but also darkening Canadian growth prospects by depressing the economy’s terms of trade. A final factor and the one most likely to persuade officials to slice rates by only 25 bps if a conservative decision is in fact made is the weakness of the Canadian dollar, which hit an 18-month low of 1.2120 on October 10th.  It had been 13% stronger when Bank of Canada policymakers deliberated in early September and had peaked nearly a year ago at USD/CAD 0.9061 last November 7th.



Comments are closed.