Bank of Canada surprises with rate cut

(July 15, 2003) The Bank of Canada has taken many people off guard by cutting its target overnight lending rate by 25 basis points this morning, taking the key interest rate down to 3%.

The bank cited the surprise hits taken by the economy in the first half of the year, including the Ontario outbreak of severe acute respiratory syndrome (SARS) and the appearance of bovine spongiform encephalopathy (BSE or mad cow disease) in Alberta as factors in its decision to cut rates.

On top of these problems, the still-sluggish American economy and the unusually high value of the Canadian dollar have both made life difficult for manufacturers that rely on exports to the U.S.

The rate cut was welcomed in a press release by the Canadian Manufacturers & Exporters (CME), but the group said it will not be enough to spur the economy forward.

“Lower interest rates will reduce borrowing costs but are unlikely by themselves to put the Canadian economy back on the road to a full recovery,” said CME chief economist Jayson Myers. “Canadian manufacturers won’t see real relief until there are clear signs that the U.S. economy is recovering.”

“It seems clear that Canada’s output gap is now anticipated to remain open somewhat longer than originally anticipated when the bank was raising rates back in the spring,” said RBC economist Carl Gomez.

“This rate cut is as well justified as the last two rate hikes were not,” said CIBC World Markets’ Avery Shenfeld, pointing out that inflation cited by the Bank of Canada earlier in the year was narrowly based in the energy and insurance sectors.

“We look for a further quarter-point cut by the bank in September as growth disappoints in Q3.”

RBC’s Gomez disagrees, saying the Bank of Canada would likely take a neutral bias toward any rate decisions in the near future.

“We do not see this as the first of several easing moves and we expect the 3% overnight rate to be maintained through the third quarter of next year. Given that the Fed is holding its rate at 1%, a steady overnight rate spread at 200 basis points will continue to be a supportive factor for the Canadian dollar.”

Filed by Steven Lamb, Advisor.ca slamb@rmpublishing.com