Bank of Canada chops interest rate to historic one per cent, declares recession

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(The Canadian Press)

By Julian Beltrame, The Canadian Press

OTTAWA - The Bank of Canada slashed its key interest rate to the lowest level in history Tuesday, conceding that the country's economy has fallen into recession and needs help to recover.

The central bank cut the trend-setting overnight rate one-half point to one per cent - below the 1.12 per cent that had served as the bank's floor policy rate in 1958 - while drastically revising downward its view of economic performance this year.

The decrease was in line with the expectations of economists, who have been calling for bold action on the parts of the central bank and the federal government in light of the quick and sharp downturn last fall that followed the destruction of savings in global stock markets.

Shortly after the central bank cut its rate, the big banks, led by Bank of Montreal (TSX: BMO.TO), TD Bank (TSX: TD.TO), Royal Bank (TSX: RBC.TO) and CIBC (TSX: CM.TO), also cut their prime lending rates by the same amount.

The prime determines the rates on everything from consumer loans and lines of credit to some mortgages and other loans.

Bank of Canada governor Mark Carney, who had previously declared the economy heading into recession in public comments, made it official Tuesday, revising the bank's forecast for 2009 last made in October from 0.6 per cent growth to a negative 1.2 per cent.

"The outlook for the global economy has deteriorated since the bank's December interest rate announcement, with the intensifying financial crisis spilling over into real economic activity," he wrote in the bank's one-page release.

"Heightened uncertainty is undermining business and household confidence worldwide and further eroding domestic demand."

In Canada, Carney said: "Exports are down sharply and domestic demand is shrinking as a result of declines in real income, household wealth and consumer and business confidence."

The Canadian dollar fell by close to a cent on the news, but had recovered most of the loss by mid-morning.

It was Carney's relatively rosy outlook for the economy after the autumn of 2009 that surprised many private-sector economists.

He forecast growth will bounce back to a rate of 3.8 per cent in 2010, saying there were faint indications that previous and current aggressive actions of central bankers and governments to inject liquidity and stimulus are yielding results.

"I think they are overly optimistic on the speed of the rebound," said Scotia Capital economist Derek Holt. "What is happening now is one of the strongest contractions in the supply of money in 70 or 80 years."

Global Insight managing director Dale Orr added that the ball is now in the federal government's court, saying next Tuesday's budget should contain significant temporary stimulus that can be implemented quickly.

At one per cent, the Canadian central bank is coming to the end of its ability to affect interest rates.

Since December 2007, when the initial signs of economic weakness appeared, Carney has chopped the overnight rate by 3.5 percentage points, as well as injected $35 billion in liquidity into money markets through asset swaps.

Next up is fiscal stimulus in the budget. Senior government officials have said Finance Minister Jim Flaherty will inject up to $30 billion - or two per cent of gross domestic product - into the economy in construction spending on infrastructure and tax cuts.

But Carney said the key test remains the availability of credit. The world economy won't begin to recover until the global financial system, which has been rocked by scandal and scandalous lending practices, stabilizes, he said.

Canada's money markets are also considerably tighter than last fall, as some non-bank lenders have closed up shop. Although the chartered banks quickly followed Tuesday's rate cut, long-term loans remain relatively expensive and difficult to obtain.

Holt is urging the government to intervene through a number of instruments, including back-stopping car leasing and possibly even purchasing toxic non-mortgage assets, to free up lending.

But not all agree. "I don't think they go there until the Bank of Canada goes down to zero or near-zero interest rate," said Douglas Porter, deputy chief economist with BMO Capital Markets.

Many economists see the central bank lowering its rate to 0.5 per cent as early as March 3.

One problem Carney won't have to worry about for some time is high inflation.

The central bank now says prices will actually tumble into negative territory for two quarters this year as the contrast between last summer's sky-high gasoline prices and this year's much lower levels pushes the inflation rate down.

The bank and most economists do not view this as deflation - an alarming condition last seen in Japan in the 1990s - because it is not expected to be prolonged and is concentrated mostly on energy prices.

Overall, inflation will average 1.1 per cent this year and now won't return to the bank's two-per-cent target until 2011, the central bank said.