Bank of Canada shocks markets with cut in key interest rate

Central bank sees 2015 economic growth of 2.1%, down from earlier forecast of 2.4%

(CBC NEWS) The Bank of Canada shocked markets today by cutting its key overnight lending rate by a quarter of a percentage point, citing the economic threat posed by plunging oil prices.

"The drop in oil prices is unambiguously negative for the Canadian economy," Bank of Canada governor Stephen Poloz said in a morning news conference. "Canada's income from oil exports will be reduced, and investment and employment in the energy sector are already being cut."

The overnight rate, which moves down to 0.75 per cent, had been at one per cent since September 2010. The cut will result in lower interest rates for variable rate mortgages, lines of credit and other loans that float with prime rates. 

Virtually no economists had been predicting a rate cut. 

"It is a significant move," TD Bank economist Derek Burleton told CBC News. "It does show the Bank of Canada is worried about the big drop in the price of oil ... and what kind of uncertainty that poses in the next few quarters.  I don't think they are panicking but I do think they're concerned about some of the uncertainty the recent slump in the price of oil does create for the economy."

"The large decline in oil prices will weigh significantly on the Canadian economy," the Bank of Canada said in its quarterly monetary policy report.

"Given the speed and magnitude of the oil-price decline, there is substantial uncertainty around the likely level for oil prices and their impact on the economic outlook for Canada."

In the wake of the rate cut, the loonie plunged more than 1.7 cents to 80.82 cents US in afternoon trading — its lowest level since late April 2009. It's the biggest one-day drop in the dollar's exchange rate since November 2011.

The benchmark index of the Toronto Stock Exchange jumped 258 points, or 1.8 per cent, to 14,564.

Lowered outlookThe central bank scaled back its forecast for the country's economic growth this year. It now sees 2015 growth of 2.1 per cent, down from 2.4 per cent.

"The negative impact of lower oil prices will gradually be mitigated by a stronger U.S. economy, a weaker Canadian dollar and the Bank [of Canada's] monetary policy response," it said.​

The central bank says real GDP growth will be just 1.5 per cent in the first half of this year and will pick up in the second half. For 2015 as a whole, it sees economic growth of 2.1 per cent, rising to 2.4 per cent in 2016. 

The bank bases its revised growth forecast on the assumption that oil will average $60 US a barrel over the next two years. 

The central bank said the oil price plunge increases downside risks to both inflation and financial stability. It said Wednesday's action was designed "to provide insurance against these risks."

David Madani of Capital Economics says the rate cut shows that the Bank of Canada "is far more worried than before about a severe housing market correction, which in our view is understandable given the recent news that home sales in Alberta have already collapsed."

Several analysts say further rate cuts cannot be ruled out.

"Today’s BoC rate cut smacks of being a one-time 'insurance' move but in his presser, Governor Poloz indicated that if the world changes again (adversely for Canada) the Bank could take out more insurance," noted BMO deputy chief economist Michael Gregory.  

Oil prices have plunged to less than $50 US a barrel from more than $105 US in June last year.

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