The BoC announced a surprise 25 basis point cut in key interest rates at today's policy-setting meeting. The target for the overnight rate is reduced to 0.75 percent and the deposit rate and the Bank Rate are lowered to 0.50 percent and 1.0 percent respectively.
Today's move in large part reflects the expected impact on the Canadian economy of the recent dramatic fall in oil prices and the consequent significant downgrading of the Bank's economic outlook (see today's MPR calendar entry). Hence, growth is now seen slowing to 1.5 percent in the first half of this year, nearly a full percentage point below the October projection. Although some pick-up in activity is expected after that, full capacity is not reached until the end of 2016, somewhat later than last time. As a result, overall and core CPI inflation both remain sub-2 percent until the end of the forecast horizon.
Ongoing concerns about the level of household debt mean that the central bank will have been reluctant to make consumer borrowing any cheaper so today's cut in rates underline's the monetary authority's sensitivity to oil market developments. Indeed, against this clearly more pessimistic economic backdrop, sustained weakness in oil prices would make another 25 basis point cut more than just a possibility further down the road.
Meanwhile, today's policy actions should ensure that the local currency's struggles against its U.S. counterpart continue for some time yet.
The central bank of Canada announces its monetary policy with regard to interest rates about eight times a year. The announcement conveys to the financial markets and investors what, if any, changes in policy might be.
Bank of Canada determines interest rate policy at eight meetings during the year and they are an influential event for the markets. Prior to each meeting, market participants speculate about the possibility of an interest rate change. A post-meeting statement is issued after each meeting. Unlike the Federal Reserve, there are no post-meeting minutes. The Bank has an inflation target range of 1 percent to 3 percent with specific focus on the 2 percent midpoint.
Although the Bank monitors many economic indicators, as indeed all central banks do, the Bank converted its inflation barometer for operational purposes to a consumer price index measure that subtracts eight volatile components to better reflect core inflation. It also takes the foreign exchange rate for the Canadian dollar into its monetary policy decisions.
Monetary policy goals are to aid and abet solid economic growth along with rising living standards. To achieve these goals, inflation is kept low, stable, and predictable. The inflation control target is at the heart of Canadian monetary policy that the Bank and the Government have established. The level of interest rates and the exchange rate determine the monetary environment in which the Canadian economy operates.
The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.