BoC keeps people guessing on rate cuts

In one of the most anticipated decisions of the year, the Bank of Canada will announce on Tuesday whether or not it’s cutting lending rates. Right now, no one knows what the BoC will do.

“There’s a 50.5% chance that there’s going to be a cut,” says Don Drummond, senior vice-president and chief economist at TD Bank Financial, adding that it’s so up in the air that he won’t round that number up to 51%.

Drummond’s comments won’t help anyone decide if there will be a cut or not, and he says making a bolder prediction is tough, considering the dollar’s recent decline and news that the economy is improving. “The Canadian economy grew by 2.9%; we’re sitting at a 5.8% unemployment rate; … the economy is on fire, so why cut interest rates?”

One thing in favour of a cut is that the summer’s market turmoil has returned, and it’s expected that growth will be weak in Q4 of this year and Q1 2008. “The financial market worries are definitely back,” he says. “Most things are back as bad as they were in the summer. If you ask me what I think the BoC should do? They should cut.”

The Bank of Montreal has a different opinion. In Focus, its weekly financial digest, the bank’s economists say that the BoC will hold off cutting rates until January. Their reasoning is that labour markets remain “exceedingly tight, and wage pressures are clearly rising,” the housing market is bustling with prices still up 10% over last year, and the Canadian dollar “has simmered down substantially.”

The Royal Bank also thinks a rate cut will happen in January. “Recent indications of firm domestic demand, combined with the very firm tone in the labour market data lately, means we lean towards the Bank holding the policy rate at 4.5%,” the bank said in a release.

To prove just how unpredictable Tuesday’s policy announcement will be, another big bank expects the cut to happen. Scotiabank economist Meny Grauman thinks the BoC will cut the overnight target rate by 25 basis points and then another quarter point in January. “The probability is definitely higher than it was even a few weeks ago,” he says.

Grauman points to David Dodge’s speech in South Africa a couple of weeks ago as proof that a rate cut might be coming as early as Tuesday. “The comments were perceived to being quite amendable to a cut,” he explains. “Dodge focused on challenges that the problems in the financial market have created, and he talked about how the Bank would most likely have to respond to those issues.”

Add to that the current credit problems and the U.S.’s shaky economy and, says Grauman, “you can see how the BoC would want to be more preemptive in anticipation of bad news to come.”

Clearly, if there’s no rate cut Tuesday, then expect one in the new year. RBC says slower U.S. growth, a higher Canadian dollar, market volatility and moderating inflation rates mean that that Bank will have to cut rates 25 basis points in both January and March.

BMO adds that “there is little doubt that the Bank will soon cut interest rates, and the only debate now appears to be over the timing of that move.”

The Bank expects an interest rate cut to eventually happen because core CPI has fallen under target and is “far below” what the BoC expected, plus the U.S.’s dire economic outlook is likely to force the Federal Reserve to cut its rates. Throw in the tumultuous markets, and there’s sure to be a cut soon. “Whether he cuts Tuesday or holds off until January, it is almost a certainty that Governor Dodge will be leaving office with rates lower than they are today,” says BMO.

Like BMO and RBC, Drummond is sure that rates will be cut in January if nothing happens Tuesday. He says a weak fourth quarter will assuage any doubts that the BoC has about cutting rates. “If my economic scenario is true, that the fourth quarter is weak, then they won’t have any hesitation to cut,” he says.

But whatever happens, there’s no debate that Tuesday is a big day for the financial industry. “This [disagreement] is pretty rare,” says Grauman. “Most market participants — investors, economists — we’re all on the same page in the lead up to these policy meetings. We don’t take this [meeting] for granted like a lot of the ones we do see.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com