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Bank of Canada Cuts; Signals More to Come
22 Jan 08
The Bank's policy rate falls as expected and another cut is in the works. The Fed cuts 75 basis points, creating a positive Canada/U.S. rate gap
The Bank of Canada today lowered its policy rate by 25 basis points, to 4.00%, as expected. The key surprise in today's announcement is the unequivocal statement that "further monetary stimulus is likely to be required in the near term." This signals that the Bank probably seriously considered cutting by 50 basis points today instead of 25. With this stance from the Bank, the markets will factor in the additional 25 basis points, if not more. This monetary stance, coupled with the observation that "the economy continues to operate above its productive capacity," as a reading of current conditions, indicates that the Bank believes the pace of economic growth is falling very rapidly at this point. The statement that the economy will be "moving into modest excess supply in the second quarter of this year," does put into perspective that the real side of the economy, particularly domestic demand, is still quite strong today, but that exports and to a lesser extent domestic demand, are expected to begin a steep decline soon, following weaker and deteriorating growth in the United States. With the 75-basis-point reduction by the Fed this morning, the Canada/U.S. interest rate gap has gone from zero to plus-50 basis points. This positive Canada/U.S. interest rate gap will, in itself, put upward pressure on the Canadian dollar. Global Insight expects more reductions from the Fed than from the Bank of Canada going forward, further widening the Canada/U.S. gap. At the same time, downside pressure on the Canadian dollar will be coming from weaker net trade and falling commodity prices. These latter factors would have to be very strong to outweigh the impact on the Canadian dollar of the increasingly positive interest rate gap. Therefore, the Canadian dollar is not likely to fall enough in the coming months to provide much monetary stimulus. We await a sorting out of these most important comments from the Bank in its Monetary Policy Report Update on Thursday January 24.
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