Bank of Canada drops interest rates to 0.75% in surprise cut

“We can’t stress enough how much of a shock this rate cut was”

(Photo: Adrian Wyld/CP)

(Photo: Adrian Wyld/CP)

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The Bank of Canada announced this morning that it is dropping its target interest rate by a quarter of a percentage point to 0.75%. The bank cited the prospect of slower economic growth in Canada brought about by lower oil prices as one reason for moderating the rate. The Canadian dollar quickly dropped by more than a cent against the U.S. dollar, a 1.5% decline. Markets rose, with the S&P/TSX rising about 1.7% by mid-morning.

“We can’t stress enough how much of a shock this rate cut was,” David Madani of Capital Economics said in a note to clients this morning. “Only a few days ago, Deputy Governor Timothy Lane said that there would not be any “drastic” changes in the policy outlook.”

In his press conference to discuss the change today, Bank of Canada Governor Stephen Poloz said that the Bank felt the ground had been prepared for a rate cut by the decline in oil prices.

“We generally prefer that markets not be surprised by what we do,” said Poloz. “In that respect, we took comfort from the observation that the consequences of the drop in oil prices appear to be well understood, and that the possibility of a rate cut had begun to enter markets in the last couple of weeks.

“Moreover, given the magnitude of the shock, we concluded that the benefits of acting now rather than waiting would outweigh the costs of any short-term market volatility that might arise.

Our own Mark Brown noted on Twitter the degree to which the market did not see this coming:

The surprise nature of the rate cut is not just a question of analyst scorekeeping. Central banks rarely make such moves without telegraphing their intentions ahead of time, and the suddenness of this move may end up undermining confidence in the wider economy.

“I’ll be interested to see what this does,” says Steve Ambler, chair of monetary policy with the C.D. Howe Institute and a UQAM economics professor. “It’s sending a signal that [the Bank of Canada’s] evaluation of the impact of oil prices is very negative. This might have an impact on business confidence at this point. People say, ‘Maybe the bank knows something we don’t, and they’ve done enough analysis that this is going to be really negative.’ It might cause people to cut back even more on investment.”

ScotiaBank Economics researchers floated the idea of a further rate cut. “Markets have moved to pricing in decent odds of a further cut,” Scotia researchers said in a note to clients this morning. “There’s a good case to be made that the Bank could get back to the lower zero bound given the extent to which markets have grown accustomed to such pricing globally.”

“Today’s BoC rate cut smacks of being a one-time ‘insurance’ move,” said BMO Capital Markets deputy chief economist Michael Gregory in a statement. But “Governor Poloz indicated that if the world changes again (adversely for Canada) the Bank could take out more insurance. As such, further rate cuts cannot be ruled out.”

Here is an excerpt of the Bank of Canada’s statement:

Oil’s sharp decline in the past six months is expected to boost global economic growth, especially in the United States, while widening the divergences among economies. Persistent headwinds from deleveraging and lingering uncertainty will influence the extent to which some oil-importing countries benefit from lower prices. The Bank’s base-case projection assumes oil prices around US$60 per barrel. Prices are currently lower but our belief is that prices over the medium term are likely to be higher.

The oil price shock is occurring against a backdrop of solid and more broadly-based growth in Canada in recent quarters. Outside the energy sector, we are beginning to see the anticipated sequence of increased foreign demand, stronger exports, improved business confidence and investment, and employment growth. However, there is considerable uncertainty about the speed with which this sequence will evolve and how it will be affected by the drop in oil prices. Business investment in the energy-producing sector will decline. Canada’s weaker terms of trade will have an adverse impact on incomes and wealth, reducing domestic demand growth.

More to come…