Bank of Canada cuts rates again
OTTAWA (Reuters) - The Bank of Canada cut its benchmark interest rate by 25 basis points to 0.5 percent on Wednesday, saying an unexpected economic contraction in the first half of the year had added to excess capacity and put downward pressure on inflation.
"Additional monetary stimulus is required at this time to help return the economy to full capacity and inflation sustainably to target," the central bank said in the interest rate decision that accompanied its quarterly Monetary Policy Report.
Bank of Canada Governor Stephen Poloz had expected a recovery by now from the oil price crash that hit Canada's oil-exporting economy in the first quarter, but that projection proved far too optimistic.
The bank now expects the economy to have shrunk at an annualized 0.5 percent in the second quarter instead of growing by 1.8 percent as Poloz had projected in April. It contracted 0.6 percent in the first quarter.
The bank did not use the word "recession" but the projection of negative growth in both the first and second quarters meets a widely accepted definition of a recession.
The market had been split on whether the bank would cut rates for the second time this year after holding them steady for about four years. The bank had delivered a surprise cut in January that was designed to counter the dive in oil prices, and markets had reacted sharply to that move.
They did so again on Wednesday with the Canadian dollar dropping to a six-year low, and Canadian government bond prices rising sharply and outperforming U.S. Treasuries. [CAD/]
The Canadian dollar tumbled to its weakest level - C$1.2929, or 77.35 U.S. cents - since March 2009 against its U.S. counterpart, hurt also by predictions that the U.S. Federal Reserve will raise rates this year.
"The currency is in uncharted waters here," said Derek Holt, vice president of economics at Bank of Nova Scotia, citing a risk that the Canadian dollar weakens to as low as C$1.30 against the greenback, then diving to C$1.40.
"If the Fed is hiking, we think by September, and the Bank of Canada appears to be leaving the door open to additional rate stimulus, all bets are off."
The bank said excess capacity in the economy grew significantly in the first half and would continue to do so in the third quarter, even with expected economic growth of 1.5 percent.
It therefore pushed back to the first half of 2017 its projection of when full capacity will be reached and inflation return to the bank's 2 percent target. Its previous projection had been for the end of 2016.
The bank acknowledged elevated vulnerabilities from a hot housing market in Toronto and Vancouver and from rising household debt, a key factor that had spurred some economists to advise against a rate cut. It said, however, that the economy was undergoing "a significant and complex adjustment" and required additional stimulus. It continued to see a soft landing in housing.
Perhaps the biggest disappointment for Poloz, former head of the federal export agency, has been what the bank said was a "puzzling" weakness in non-energy exports. He had hoped such exports would help overwhelm the negative effects of lower oil prices on business investment and incomes.
But the bank said its base-case projection assumes "that this unexplained weakness is temporary and that the relationship between exports and foreign activity will reassert itself in the coming quarter".
The bank said the main dangers to its inflation outlook were a larger-than-expected decline in oil and gas investment, weaker non-energy exports, imbalances in the Canadian household sector and stronger U.S. private demand.