Bank of Canada Lowers Overnight Rate Target to 0.50%

July 15, 2015

After weeks of speculation by economists, the Bank of Canada announced Wednesday, July 15, that it is cutting its target for the overnight lending rate to 0.50% from 0.75%, the second decrease this year.

The Bank cited more moderate global and domestic growth, disinflation and low prices for oil and other commodities for the rate-cut decision. Bank of Canada Governor Stephen Poloz also acknowledged that the failure to get a lift from non-energy exports is “puzzling.”

The Bank said it expects domestic growth for the year to hit 1.1 per cent, down sharply from the 1.9 per cent it forecast three months ago, and anticipates that the Canadian economy won’t return to full capacity until the first half of 2017.

Oil and the Canadian economy

Canada’s economy has contracted in the first four months of this year, and may be in technical recession through the end of the second quarter, although the Bank of Canada stopped short of characterizing it as such.

Oil prices continue to dampen Canadian economic perspectives, and are below the Bank of Canada’s expectations. Global oil prices have fallen within the last two weeks, but still remain above the lows seen in the first quarter of 2015. This recent movement can be largely attributed to an ongoing imbalance of supply and demand.

Gross Domestic Product

Following weak results in the first quarter of 2015 – a result of falling oil prices, harsh North American weather and poor business investment – real GDP by industry fell 0.1% month over month in April. It was the fourth consecutive one-month decline and the fifth in the last six months. GDP growth continues to be disrupted by the effects of the drop in oil prices.

Real GDP is now projected to have contracted modestly in the first half of the year, resulting in higher excess capacity and additional downward pressure on inflation. The Bank projects that Canada’s real GDP will grow by just over one per cent in 2015, and about 2.5% in 2016 and 2017.

Inflation

The Central Bank’s rate policy is guided by an inflation target of two per cent, and its analysis of various economic forces is tied to their expected impact on the country’s inflation rate. The Consumer Price Index has been around one per cent in recent months, reflecting year-over-year price declines for consumer energy products, while core inflation has been close to two per cent. The June Consumer Price Index report will be released on Friday, July 17.

Currency

The Canadian dollar fell more than a cent following the Bank of Canada’s decision. Business investment for natural resource-focused industries is unlikely to expand without confidence for higher future commodity prices. However, lower financing costs and a lower Canadian dollar better positions non-energy exporters (i.e. automakers and other manufacturers) to benefit from a more robust U.S. economic expansion.

What does the decision mean for consumers?

A more accommodative monetary policy provides access to cheap financing for both consumers and businesses. Although the Canadian consumer is already heavily indebted, this added stimulus supports their capacity for short-term spending. The Bank of Canada acknowledged today that the risk of weak growth and disinflation outweighs concerns that Canadians may add to their debt load.

How does the Bank of Canada decision impact MD portfolios?

We repositioned our portfolios for a reduced allocation to Canadian equities in mid-June. Supported by ongoing consumer spending, accommodative policy positioning and investors’ demand for yield in a low- return environment, Canadian equities are positioned for positive absolute return. However, we expect that energy prices may contribute to underperformance compared to foreign equities.

We expect bond yields, especially at the short end of the Government of Canada curve, to remain low for the foreseeable future. To improve expected performance from our fixed-income allocation, we also recently introduced strategic enhancements designed to meet our clients’ investment objectives across multiple market environments, including changes in interest rates.

Next Bank of Canada interest rate announcement

The next scheduled date for announcing the overnight rate target is September 9, 2015.

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