Bank of Canada Still Playing Catch-Up
The good news is that the Bank of Canada today matched the maximum market expectation of them, a half point cut in the target for the overnight rate. They even suggested that further interest rate cuts are in store. “Further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to achieve the 2Â perÂ cent inflation target over the medium term.” Newly-appointed Governor Carney is off to a good start.
The soundly-based reasons for this rate decision were clearly stated by the Bank as follows:
“Canada’s net exports weakened further in the fourth quarter, reflecting the slowing U.S. economy and the impact of the past appreciation of the Canadian dollar….. there are clear signs that the U.S. economy is likely to experience a deeper and more prolonged slowdown than had been projected in January. This stems from further weakening in the residential housing market, which is adversely affecting other sectors of the U.S. economy and contributing to further tightening in credit conditions. The deterioration in economic and financial conditions in the United States can be expected to have significant spillover effects on the global economy. These developments suggest that important downside risks to Canada’s economic outlook that were identified in the MPRU are materializing and, in some respects, intensifying.
The Bank now judges that the balance of risks around its January projection for inflation has clearly shifted to the downside, and, as a result, the Bank is lowering the target for the overnight rate.”
That said, with the Canadian dollar currently trading at above parity, with the balance of payments on current account now in deficit due to slumping manufacturing and forestry exports, and with core inflation running at a very subdued 1.4% in January, a half point cut was the minimum needed.
To put it in context, the Bank of Canada has now cut interest rates byÂ three quarters of a percentage point this year and by one percentage point since last September, while the US Federal Reserve cut its policy rate by 1.25 percentage points in January alone , and has cut rates by fully 2.25 percentage point since last September. To be sure the US economic outlook is worse than that of Canada, but the Bank of Canada has not cut by enough to close a widening Canada-US interest rate differential which supports an over-valued exchange rate.
Reading between the lines, the Bank of Canada will likely match future US rate cuts. But they still seem remarkably comfortable with a dollar at parity, reasoning that a fast-slowing export sector is needed to take some of the steam out of a domestic economy which they still think is running above capacity. The problem is that the structural damage to export industries is likley to be permanent, and hardly justified by a non existent inflation problem.