Bank of Canada Lowers Overnight Rate Target to 0.75% – MD Portfolios Remain Well Positioned

January 23, 2015

The Bank of Canada (BoC) has reduced its target for the overnight lending rate to 0.75% from 1.0% in a bid to further stimulate economic growth. The move was largely unexpected with the rate remaining unchanged since September 2010. The initial reaction from capital markets included a significant decline in Government of Canada bond yields and a lower Canadian dollar, both of which are considered supportive for sustained growth. Canadian equity markets rose on the news.

How does the BoC decision impact MD portfolios?

MD’s positioning in light of the BoC decision to cut rates is unchanged. We believe our portfolios remain well positioned. MD currently holds an overweight tactical allocation to fixed income assets relative to equities overall. In terms of our regional allocations, however, we have an overweight position in Canadian equities compared with our allocation to U.S. and international stocks.

In general terms, we expect the rate cut will have a positive impact on asset class prices. Moreover, the lower Canadian dollar will assist exporters and help support business investment.

The BoC’s move comes amid divergent policy changes by central banks around the world to support the global economy. MD will continue to monitor the actions of global policy makers with the expectation that their decisions will likely lead to continued economic expansion.

The BoC rationale

In a statement, BoC Governor Dr. Stephen S. Poloz said he expects a boost to global economic growth as energy consumers benefit from the decline in the global price of oil. Still, the commodity’s recent price weakness presents negative risks for Canada’s inflation and economic growth.

In particular, Canada’s already high consumer debt levels may grow as access to lower energy costs and cheap credit could stimulate consumption of other goods and services. This continues to pose a threat to the country’s domestic financial stability, according to the BoC. However, the Bank expects consumer spending to slow in the short-term as lower oil prices cause higher unemployment and lower income growth.

Gross Domestic Product (GDP)

With the rate announcement, the BoC also released its latest Monetary Policy Report. Within the report, the Bank provided the rationale for lowering its 2015 economic growth forecast to 2.1% from 2.4%. The net impact of lower oil prices will be negative for domestic expansion in the first half of 2015 as reduced business investment within energy-related industries restrains household spending. However, the Bank anticipates that exports from the manufacturing sector will benefit from a lower Canadian dollar, improved economic growth in the U.S., and lower input costs. The Canadian economy is expected to return to full capacity by the end of 2016, which is only a mild revision from the previous expected recovery target of October 2016.

Inflation

In the 12 months through November 2014, both core (2.1%) and headline inflation (2.0%) were broadly aligned with the Bank’s target level. Any perceived inflationary pressure is considered transitory—in part a result of elevated food and telecommunication costs. But headline inflation is expected to fall below 1.0% in 2015 as a result of lower oil prices and underlying pressure from a continuing output gap. Inflation is then expected to migrate back to target toward the end of 2016.

Next announcement

The next interest rate announcement is scheduled for March 4, 2015.

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