The Bank of Canada has just announced that it is cutting its key policy-setting interest rate, the “overnight rate”, by 50 basis points (100 basis points =1.00%). This will drop the overnight rate from 4.00% to 3.50%. The lowering of the rate is being initiated to help with a slowing economy, partly as a result of spillover effects from the slowdown/recession in the United States. It is believed that this will not contribute significantly to inflation in Canada. The year-over-year increase in the all-items Consumer Price Index is a still-low 2.2%, while core inflation is only 1.4%.

This latest action by the Bank of Canada will lower the gap with the federal funds rate in the United States, which currently sits at 3.00%. As a result, some pressure should be taken off the value of the Canadian dollar, which has recently been above parity with the U.S. dollar.

The decline in the Bank of Canada rate will be quickly met by lower prime and mortgage rates. This may give a slight boost to housing starts, but there are other indications that fewer Canadians are intending to buy new homes this year than last year.

The decline in interest rates is probably not over. Most analysts expect the overnight rate to be 3.00% by this summer. That is a level considered to be essentially neutral in economic parlance. It is neither too restrictive nor too stimulative. A more complete story on this rate change (including a graph and a table) has been be posted in the “Economics & Finance” channel of RCD’s Market Insights.

Alex Carrick

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