Bank of Canada Monetary Policy Update for January 2015

Bank of Canada Monetary Policy Update

In what comes as a surprise, the Bank of Canada slashed its benchmark interest rates from 1% to 0.75%, a 25bps cut, citing the oil price shock. While the markets were expecting a rate cut later this year, today’s move by Canada’s Central Bank clearly shows that Canada would now prefer to see a weaker Canadian Dollar in order to offset the downward pressure due to Oil prices.

In terms of the Canadian economic outlook, the BoC cut down its economic projections, expecting growth now to rise at a slower pace of 2.1% in 2015, down from previous forecasts of 2.4% GDP growth with expectations that the economy would return to full capacity by late 2016.

Regarding the inflation outlook, the BoC expects headline inflation for most part of 2015 to be around 0.5%, with the possibility of falling to 0.3% before starting to rise higher in 2016. The downward revision on inflation expectations now puts the CPI forecasts well below the BoC’s target rate of 2%.

The Canadian Dollar weakened considerably on the news, falling close to 2% against the Euro as well as the US Dollar. The Loonie touched a new high at 1.242 after the announcement and also declined considerably against the British Sterling.

From the BoC’s press conference following the surprise rate cuts, Governor Poloz noted that as per the BoC’s original estimates, it would take until late 2017 to eliminate excess capacity and the rate cuts were made to speed up the process. He further went on to justify that the lower interest rates would help encourage the housing markets which could allow new home owners to borrow while at the same time cushion the decline in the labor markets and incomes. The decline in Oil prices, he noted was starting to take a toll in the Canadian Oil industry.

In a clear indication that the rate cut was not a one off event, Governor Poloz noted that the BoC has room to maneuver if its forecast on economic outlook and Oil is too optimistic or pessimistic. Commenting on surprising the markets, the Governor noted that the markets were already starting to talk about rate cuts since the past few weeks. He concluded the press conference by stating that the benefits of the BoC acting now outweighed the risks of bearing short term volatility due to surprise moves later on.

Some economists view today’s BoC rate cuts as a response to the Swiss National Bank’s move last week. If this view is expected to be true, we could possibly see more Central bank surprises in the near term.