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Central bank gives alert on economy
Slashes forecast, makes quarter-point cut
October 22, 2008
OTTAWA -- Canada faces a long period of economic stagnation caused by a potent mix of global forces that lie largely beyond Canadian policy makers' control, the Bank of Canada suggested yesterday.
The central bank cut its key interest rate by a quarter of a percentage point yesterday - a move designed to bolster confidence and give borrowers a break. It also indicated that there likely will be more interest rate cuts to come.
But the central bank as much as said that these measures won't be enough to revive the Canadian economy and move supply and demand back into balance until at least the end of 2010.
Three main forces - the worldwide financial crisis, sliding commodity prices and a global economy in recession - are feeding off each other and "are having a profound impact on the Canadian economy," the bank said in a lengthy statement notable for its gloomy tone and starkly downgraded growth projections.
The U.S. economy is already contracting, and Canada will eke out an expansion of just 0.6 per cent this year and next, the bank said. Its previous forecast for 2009 was 2.3 per cent.
"The Bank of Canada can't single-handedly change things," said James Marple, economist at Toronto-Dominion Bank.
Yesterday's rate cut, together with a major half-percentage-point cut on Oct. 8 and a raft of recent measures to ease lending between Canada's banks, will help bring down borrowing costs in Canada, and encourage households and companies not to sit still, he said.
So long as commercial banks agree to pass along the central bank's rate cut by lowering their own prime rates - which they did yesterday - borrowers should take the Bank of Canada's moves as a shot in the arm, added Angela Redish, economics professor at the University of British Columbia.
But the global financial turmoil and recession are too powerful for Canada to withstand, Mr. Marple said. "We're going to get the hit, regardless of how low we get interest rates."
Domestic consumption is also vulnerable, since falling commodity prices are slashing the country's income and hurting consumers' spending power, the central bank said.
With the Bank of Canada acknowledging that growth has virtually ground to a halt, and inflationary pressure disappearing quickly, several economists questioned the wisdom of cutting rates by just a quarter of a percentage point.
But the central bank offered several reasons for not acting more aggressively. It just cut a half-percentage point two weeks ago. Plus, the rapid and steep depreciation of the Canadian dollar is helping to stimulate the economy.
And things are changing so quickly in the global economy and on financial markets that the bank suggested it preferred to move incrementally.
The small rate cut may not instill confidence among economists, but it sends out less of a panic signal to the Canadian public than a large rate one, Prof. Redish pointed out. "I was thinking they should do a bit more," she said. "But the confidence thing goes two ways."
Toronto-Dominion Bank was the first to move in the wake of the central bank's cut, dropping its prime rate by 35 basis points (a basis point is 1/100th of a percentage point). Two weeks ago, TD had dropped prime by only 40 basis points despite the central bank's half-percentage-point cut. "Funding costs for the Canadian banks have come down nicely," said Tim Hockey, president and chief executive officer of retail arm TD Canada Trust. "We're not out of the woods yet, but trend lines are going the right way, so we were comfortable passing on the full rate cut."
Headwinds
The Bank of Canada highlights three global forces out of its control.
WORLDWIDE FINANCIAL CRISIS
More than $3-trillion (U.S.) has been committed to bailing out the world's financial sector. Famous banks and brokerages have failed, been taken over or partly nationalized. Those remaining are wary of lending, hampering a recovery.
FALLING COMMODITY PRICES
Canada is a commodity producer and is vulnerable to drops in demand or prices. A barrel of oil costs less than half what it did four months ago. Everything from copper to potash has plunged amid global economic weakness.
THE GLOBAL SLOWDOWN
Central banks around the world are reducing growth outlooks. The word "recession" is being uttered in the same sentence with places such as the United States and much of Europe. Emerging markets, once the source of most economic growth, are stalling.
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