Bank of Canada slashes key rate

by Greg Bonnell, Reporter, BNN.

Canada’s central banker isn’t using the R-word – recession — but Stephen Poloz is cutting the Bank of Canada’s key interest rate by 25 basis points to 0.5 percent as he forecasts two back-to-back quarters of economic decline amid the crash in crude prices.

With Canadians carrying record-high debt loads and cheap money fuelling hot housing markets in Toronto and Vancouver, the 25 basis point rate cut will be seen as a risky play in some quarters, adding more fuel to the debt fire.

The next shoe to drop for borrowing costs — Canada’s big banks and their prime rates. TD Bank was first out of the gate to cut its prime rate 10 basis points to 2.75 percent. Eager to protect net interest margins, the banks were slow to follow January’s surprise 25 basis point cut from the BOC, and when they did it was with a 15 basis point reduction in prime to 2.85 percent.

The Bank of Canada sees the economy contracting further. After contracting 0.6 percent in the first three months of the year, the Bank of Canada expects the economy to shrink 0.5 percent in the second quarter before growing 1.5 percent in the third quarter.

The downgrade to Canada’s economic prospects is forcing the bank to slash its full-year growth forecast to 1.1 percent, down from 1.9 percent. It sees 2.3 percent growth in 2016 and 2.6 percent in 2017.

“I’m not going to engage in the debate over what we call this,” Poloz told reporters in Ottawa. “No doubt, we have worked our way through a mild contraction.”

While the price of oil and the resulting plunge in energy patch business investment is the obvious culprit, the bank admits in its Monetary Policy Report that the extent of the weakness in non-energy exports is “puzzling.”

With Canada’s growth outlook “marked down considerably,” the bank says “additional monetary stimulus is required at this time to help return the economy to full capacity.”

The central bank is also pushing back its target date for the economy to return to its full potential and for inflation to land at 2 percent to the first half of 2017.

The resumption of economic growth in the third quarter, the bank says, will be driven by non-resource exports and “federal fiscal stimulus.” Does that mean the bank is anticipating economic stimulus from Ottawa in an election year? It doesn’t appear so. Rather, the bank says already announced payments to families with children will give households more disposable income, boosting consumption.

When Poloz surprised the markets with the January rate cut he said the bank was taking out “insurance” against the effects of low oil. And although he saw the fallout from crude hitting swift and hard in the first quarter, growth would resume in the April-May-June period to the tune of 1.8 percent.

Then April GDP came in negative, and May trade data further fuelled concerns that Canada wasn’t coming out from under the oil overhang as quickly as hoped.

That’s when the R-word, recession, entered the conversation as economists crunched the numbers and said it was likely Canada would see two back-to-back quarters of negative real GDP.

But with nearly 100,000 jobs added to the Canadian economy this year, hot housing markets, and auto sales on the upswing, some economists have a hard time using the R-word.

In short: the economic downturn just isn’t broad-based enough to meet the recession definition.

Scotiabank’s Derek Holt went as far as to call it the Great Canadian Non-Recession.

Still, there’s little doubt the pain is acute in the energy sector. In its report, the bank says about one-third of the income gains tied to commodity price increases since 2002 have been reversed. And business investment in the oil and gas sector is estimated to have contracted some 40 percent this year, deeper than the bank’s previous estimate of 30 percent.

The bank also says it’s anticipating “further job losses in oil and related industries.”

When it comes to the “puzzling” loss of momentum for non-energy exports, the bank says the “unexplained weakness” is likely temporary as foreign demand firms up – namely as the U.S. economy strengthens.

When it comes to the price of a barrel of crude, the bank says it’s assuming prices will remain near recent levels of $60 US for WTI, although a barrel has fallen significantly below that in recent days.

And it sees the Canadian dollar at 80 cents US.

And about those hot housing markets that some fear could become dangerously overvalued, and face a sharp correction, as Poloz cuts rates yet again – the bank says it still expects a “constructive evolution,” meaning the market will stabilize over the next two years.