News: Interest rate cut in Canada

OTTAWA — The Bank of Canada cut its benchmark lending rate Tuesday by a quarter point to 0.25 per cent and said it would provide excess cash to the financial system on a daily basis in the hopes it will passed on to consumers and businesses in the form of loans.

The central bank also took the unusual step of signalling that its record-low rate would remain as is until the end of June of next year based on its tepid inflation forecast.

Moreover, it has revised downward its outlook for the economy, forecasting a contraction of three per cent for 2009, followed by growth of 2.5 per cent next year. Previously, it had indicated the economy would shrink 1.2 per cent in 2009, followed by a robust 3.8-per-cent gain in 2010. Further, the central bank does not envisage that core inflation will reach the desired two per cent target until mid-2011.

"While more aggressive monetary and fiscal policy actions are underway across the (Group of 20 nations), measures to stabilize the global financial system have taken longer than expected to enact," the central bank said in its accompanying statement. "As a result, the recession in Canada will be deeper than anticipated."

The Bank of Canada's rate announcement, along with accompanying changes to its financial operations, lay the groundwork for the central bank to unveil Thursday its much-anticipated framework on quantitative easing — which entails flooding financial markets with excess cash in an effort to lower lending rates and stimulate the economy.

Shortly after the central bank's decision was announced, all of Canada's big chartered banks moved to lower their prime rates — or what they charge their best customers — by 25 basis points, to 2.25 per cent, effective Wednesday.

Charmaine Buskas, senior economics strategist at TD Securities, was among those forecasting a rate cut, but she said the amount of detail in the announcement caught market participants off guard.

"What did come as a surprise . . . was the astonishing transparency by the bank as it explicitly stated that rates will remain at this level until June, 2010. This level of transparency is unprecedented but it speaks to the dire state of the economy and a desire to control expectations."

Analysts feared another rate cut could disrupt the functioning of money markets. To mitigate any disruption, the central bank opted Tuesday to narrow its operating band to 25 basis points — which in effect means the interest it pays on chartered banks' deposits at the central bank will match its overnight rate. The central bank will continue to charge lenders 0.5 per cent for loans.
Previously, the operating band was at 50 basis points — meaning it charged 25 basis points above the benchmark for loans, and paid 25 basis points below the benchmark for deposits.
Meanwhile, the central bank provided a glimpse of what may be contained in its much-anticipated quantitative easing framework. The Bank of Canada said it would be changing the terms of one of its current short-term facilities, from one- to three-month terms, to six- and 12-month terms. The rollover of existing stock into longer terms, to begin next month, was necessary, it said, to keep the overnight rate at 0.25 per cent.

Finally, and perhaps most important, the central bank said it would look to provide $3 billion a day in excess settlement balances in the system, to encourage competition among market participants that would, in turn, reinforce the 0.25-per-cent rate.

Buskas said the intent is to provide more liquidity than required, in the hope market participants will use it to lend. As a result, quantitative easing may have begun on a "philosophical" basis, she said, by creating extra cash in the system.

One of the goals of quantitative easing — which generally sees a central bank acquire a range of securities from market participants, without offsetting those costs on its balance sheet — is to lower rates across the yield curve.

"Conditional on the outlook for inflation, the (benchmark) rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target."
The Bank of Canada sets interest rates in an effort to get core inflation to the two per cent level. In its statement, it said it expects core inflation — which strips out volatile elements such energy — to diminish through the year, and not return to target until the third quarter of 2011. "While the underlying macroeconomic risks to the projection are roughly balanced, the bank judges that . . . the overall risks to its inflation projections are titled slightly toward the downside."

As for the economy overall, it said it expects the recovery to be delayed until the fourth quarter of this year, and that the recovery would be "more gradual."

The economy is not expected to reach full potential until mid-2011, or roughly a year later than its previous forecast.

"Given significant restructuring in a number of sectors, potential growth has been revised down," the central bank said. "The recovery will be importantly supported by the bank's accommodative monetary stance."

Andrew Pyle, wealth adviser and markets commentator at ScotiaMcLeod, said the bank's downgrade to its economic forecast might be a bit harsh given recent encouraging signs, especially in the United States.

"The recovery itself is now seen as also being more gradual — quite a contrast to the bank's earlier forecasts for ballistic growth in 2010. That outlook was too rosy then, and I believe Tuesday's gloomier call is also a bit overdone."

© Copyright (c) The Vancouver Sun

Bilibala's comments:
In the old day, equity market go up when interest rate go down. However, start from the technology bubble in late 90s, this logic has changed. The market up when interest up and down when interest down.

I think this time will be the same. We cannot confirm we've returned to bow market until interest rate start rising.

Lots investors choose to wait until that day to return to equity market and some choose to guess about where is the bottom. To me, I choose to invest & then hold when I seek any company with reasonable price, attractive business and bright future.