Target Overnight Rate Drops to 3.50%
The Bank of Canada announced today 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 in response to the slowdown/recession underway in the United States. The peak level for the Bank’s key rate in this cycle was 4.50%, which occurred in late summer-early fall of last year.

The Bank’s report that accompanied the rate announcement included the following commentary: “The deterioration in economic and financial conditions in the United States can be expected to have significant spillover effects on the global economy.”

 It is believed that the rate cut 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%.

Narrows the Gap with the Federal Funds Rate
This latest action by the Bank of Canada will lower the gap with the
U.S. Federal Reserve’s federal funds rate, 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. This will be welcomed by Canadian manufacturers who are dependent on U.S. export sales.

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.

More Cuts to Come
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.

The Bank of Canada is next scheduled to meet and consider its interest rate policy on April 22, 2008

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