Consensus mounts that central bank will shave key rate

Economists expect cut to 0.25% next week as slump in oil continues to batter country

A growing number of economists predict the Bank of Canada will cut interest rates next week in response to the deepening economic hit from slumping oil prices.

The move should lead to lower borrowing costs for consumers and business, which could boost spending and also put further downward pressure on a falling Canadian dollar relative to the U.S. dollar, which could help boost exports.

However, economists also cautioned that after eight years of historically low rates, a further cut could have mixed results potentially further boosting house prices in overheated markets like Toronto and Vancouver, while only modestly helping drive exports.

Canadian consumers are already carrying record levels of debt, they note.

The Bank of Montreal and Canadian Imperial Bank of Commerce are the latest to join a chorus of forecasters predicting a quarter-point cut in the central bank rate on Jan. 20.

That would take the Bank of Canada’s trendsetting rate back down to a record low 0.25 per cent and mark the third time in a year the bank has cut rates to prop up the economy.

“We now suspect that the balance of factors leans toward a third 25-basis point rate trim at Wednesday’s decision,” BMO chief economist Doug Porter and senior economist Benjamin Reitzes predicted in a research note Thursday.

Crude oil prices fell below $30 (U.S.) a barrel on Wednesday, down 70 per cent from their peak in June 2014, the key reason for their change in position, they said. Crude oil regained some lost ground Thursday, closing at $31.16 for West Texas Intermediate.

“We see the odds having tilted in recent days, and are now ever so slightly on the side of seeing a rate cut in January, or April at the latest,” Avery Shenfeld, chief economist at CIBC, said in a note Thursday.

The plunging price of crude oil, Canada’s second largest export, has wiped out billions in economic value, pushed Alberta into recession, and taken Canada’s dollar below 70 cents U.S., a 13-year low. The Canadian dollar slipped further Thursday to close at 69.63 cents U.S., down .08 of a cent on the day.

Toronto Dominion Bank chief economist Beata Caranci first raised the possibility of a rate cut in a note Wednesday, citing the Bank of Canada’s quarterly Business Outlook Survey, which showed business investment and hiring intentions at their lowest level since the Great Recession of 2008/09.

With financial markets in turmoil on fears China’s massive economy is slowing, sentiment among investors is also shifting. Roughly half now expect a rate cut, up from 16 per cent a month ago, Bloomberg reported, citing trading in overnight index swaps. The Toronto Stock Exchange benchmark index rose 165 points to 12,336.03 but is down 12.4 per cent from a year ago.

A rate cut would likely put further downward pressure on the already low Canadian dollar.

Bank of Canada governor Stephen Poloz said in a speech last week the low dollar is helping the economy adjust to weak oil by making Canada’s exports more competitive. “Movements in exchange rates are helping economies, including ours, make the adjustments that must take place,” he said.

The manufacturing sector, which suffered when the dollar rose to a November 2007 peak of $1.08 (U.S.), is expected to regain some lost ground now that the dollar has fallen back.

There were glimmers of hope in November’s trade data, which showed Canada’s exports rose 0.4 per cent to $43.3 billion, reversing three months of declines, Statistics Canada said on Jan. 6. Sales of motor vehicles and parts, Canada’s largest export, led the gain.

But the rotation from oil to nonenergy exports is taking longer than expected, with Poloz saying it could take three to five years to adjust.

He also said a low dollar makes imports more expensive, saying Canadians will just have to get used to it as long as the price of crude oil is low.

In the short term, a lower dollar is attracting more U.S.-based film companies looking for cheaper locations for shoots. It’s also made Canadian destinations like Toronto more attractive to U.S. tourists.

On the other hand, Canadians are feeling the pain in higher prices for imports, most noticeably fruits and vegetables, along with vacations priced in U.S. dollars. It’s also blunted the savings at the gas pump as crude oil and wholesale gasoline are both priced in U.S. dollars.

The sliding Canadian dollar, already down 16 per cent last year, threatens to “deliver a hammer blow to already-sagging consumer confidence . . . and unleash a wave of price increases on a wide variety of imported goods and services,” BMO’s Porter and Reitzes cautioned.

The central bank might want to hold its fire until after the new federal Liberal government unveils its first budget, likely in late March, economists said. The government was elected on a promise to invest $60 billion over 10 years in infrastructure to boost economic growth.

“We would argue that a larger fiscal stimulus package that has the federal government do the additional borrowing/spending would be preferable for longer term financial stability,” CIBC’s Shenfeld wrote.

Federal Finance Minister Bill Morneau, in Manitoba as part of crosscountry pre-budget consultations this week, said foreign investors have reason to remain optimistic about Canada’s economy.

“Outside investors should be confident about Canada,” Morneau said Thursday when asked if the weaker dollar reflected doubts about the economy’s strength. “We live in a fantastic country with abundant natural resources, of course, but also a highly educated workforce. And we have the room to make some significant investments to stimulate our economy and to create a more productive Canada over the long term.”

The Bank of Canada held its overnight rate to 0.25 per cent for much of 2009 and 2010 as the global economy clawed its way out of the U.S.-led financial crisis and recession that followed. (The overnight rate is the rate the chartered banks charge each other for overnight funds.)

Scotiabank said the Bank of Canada should stand pat on Jan. 20.

The C.D. Howe Institute’s Monetary Policy Council recommended the Bank of Canada keep its target for the overnight rate, at 0.50 per cent at its next announcement on Jan. 20, 2016, and maintain it at that level for the rest of the year.