This morning, the Bank of Canada lowered its key target interest rate from 3.5% to 3%. This welcome move was widely predicted. Perhaps more interestingly, the Bank stated that “some further monetary stimulus will likely be required to achieve the inflation target over the medium term.”
Since December, the Bank has begun following the advice that the labour movement provided throughout 2007. Indeed, today’s release pointed to “the cumulative reduction in the target for the overnight rate of 150 basis points since December.”
But it is important to put this figure in perspective. The Bank strangely raised its rate from 4.25% to 4.5% in July. Therefore, the net reduction over the past year has been only 1.25% (or 125 basis points, in Bank-speak).
Meanwhile, the US Federal Reserve cut its target rate more than twice as much: by 3% (or 300 basis points) from 5.25% to 2.25%. In other words, American interest rates have gone from being a full percentage-point higher than Canadian interest rates to being almost a percentage-point lower.
This reversal of the interest-rate differential partly explains why international financiers have been so keen to hold loonies instead of greenbacks. As a result, the exchange rate has remained at parity despite the fact that economic fundamentals warrant a lower Canadian dollar. To correct this financial imbalance, the Bank of Canada should implement today’s suggestion of further interest-rate reductions.
That said, there is legitimate doubt as to how quickly lower central bank rates will translate into lower borrowing costs for businesses and consumers. Clearly, monetary stimulus alone will not be enough to safeguard Canada’s economy.
UPDATE (April 23): The chartered banks eventually matched the Bank of Canada’s cut.
- Inflation Collapse Confounds Monetary Hawks (May 17th, 2013)
- Polozogistics: Nine Thoughts About the Choice of the New Bank of Canada Governor (May 3rd, 2013)
- Breaking The Taboo on Monetizing Deficits (February 22nd, 2013)
- What Does the Bank of Canada Do? (January 7th, 2013)
- Mark Carney’s tenure and the state of monetary policy (November 27th, 2012)