Bank of Canada Rate Drop Announcement

Bank of Canada cuts target rate by 25 bps to 0.25%; provides "conditional
commitment" to hold policy rate at 0.25% until end of 2010

The Bank of Canada cut the target for the overnight rate by 25 basis points to 0.25% citing a deeper-than-expected recession in Canada and the fact that "measures to stabilize the global financial system have taken longer than expected to enact". Markets were evenly split on whether the Bank would cut by 25bps or leave the target for the overnight rate at 50bps. In a twist to its usual policy, the Bank indicated that it did not lower the deposit rate paid on deposits by financial institutions at the BOC. Under normal circumstances, the deposit rate would also be cut by 25 basis points however to avoid distortions in short-term money markets, the Bank left the deposit rate unchanged. The Bank rate was cut to 0.50%.

The Bank also committed to keeping this rate structure until the end of the second quarter of 2010 in an effort to ensure that the inflation rate gravitates back to the 2% target over the medium term. While no mention of quantitative or credit easing was made in today's statement, the Bank stated that it "retains considerable flexibility in the conduct of monetary policy at low interest rates" and a framework will be outlined in Thursday's Monetary Policy Report.

The statement provided the broad strokes of the Bank's economic forecast update with details to follow in Thursday's Monetary Policy Report. On the back of recent reports, the Bank downgraded its forecast and now looks for the economy to continue to contract in the third quarter of the year. The 2009 forecast for real GDP growth was revised down to show a 3.0% decline compared to January's forecast of a 1.2% slip. The longer and deeper recession in 2009 will also put strains on the economy in 2010 and the Bank lowered its growth forecast to 2.5% from 3.8%. The Bank provided a forecast for 2011 real GDP of 4.7%. Against the weaker growth backdrop, the Bank now looks for the inflation rate to return to its target in the third quarter of 2011 rather than the second quarter and said that risks to the
projection are "tilted slightly to the downside."

Today's announcement was different in many ways relative to past statements and importantly provided a "conditional commitment" to holding both the target and deposit rate at one-quarter of a percent for a specific time frame (until the end of the second quarter of 2010). While the Bank did not produce or commit to using any other tools to implement additional easing in monetary policy, the details of their program on be released on Thursday will provide the means by which next steps can be taken if the economy disappoints the Bank's already-weak economic assumptions. The Bank also provided the detailed framework which it will use to conduct policy during this new regime. By providing removing some of the uncertainty about the direction of interest rates over the next year, the Bank is working hard to boost the confidence of Canadian households and businesses with the goal of putting the economy on a firmer growth path.