BoC prescribes surprise interest rate drop to manage oil slump

Governor Poloz said he remains encouraged by signs of economic life in Canada's non-energy sector.

January 22, 2015   by The Canadian Press

OTTAWA — Bank of Canada governor Stephen Poloz says the economy has been suffering from the effects of an “oil shock,” so he prescribed a remedy: an unexpected interest rate cut.

To deal with the impact of falling oil prices, Poloz lowered Canada’s trend setting rate Wednesday from 1% to 0.75%, a move that blindsided the vast majority of experts.

Many economists were anticipating the central bank would hold off on moving the rate until late 2015 or early 2016, with the next adjustment expected to be a hike.

But Poloz took another route, as the central bank called the effect of plummeting crude prices “unambiguously negative” for the oil-exporting country’s economy.

“We have an oil-price shock, which will reduce the income flowing into Canada and lead probably to some increase in unemployment overall,” Poloz told a news conference.

Until the effects of oil’s late-2014 tailspin started to trickle through, Canada appeared to be on the cusp of a promising post-recession rebound – and inching closer to a rate increase.

Still, Poloz said he remained encouraged by signs of economic life, particularly in Canada’s non-energy sector, thanks to a low loonie and robust growth in the US.

That’s where the central banker said his rate-cutting plan comes in.

Poloz’s solution aims to buffer the positives still present in the healing Canadian economy from potential damage inflicted by low oil.

The goal is to give businesses, such as manufacturers still hobbled from the 2008-09 downturn, enough time to reinvest in their operations using cheaper credit and, eventually, create jobs.

“We think that the positive trend is underneath the surface, that things are getting stronger,” Poloz said.

“I think that this is a setback, it’s an interruption if you like, in our path back to where we planned to go. It’s delaying things by perhaps as long as a year.”

He described the bank’s plan as “insurance,” a move intended to shorten that delayed recovery.

Poloz also sought to ease potential public fears when asked whether the rate cut signals he’s worried about the health of the economy. He said he wouldn’t put it quite that way.

“That doesn’t mean that there’s a really bad thing, or a drastic thing, happening here,” Poloz said of the rate reduction.

“For us, it’s a more a matter of repositioning the economy in such a way that it fires on all cylinders.”

The bank also offered assurances that the rate drop would not increase Canada’s high level of household debt.

But it did reiterate the warning that Canadians remain vulnerable to economic shocks due to near record high housing prices and debt.

The bank has blamed the accumulation of debt on the extended period of the already low interest rate of one per cent, which helped propel consumer spending.

However, Bank of Canada senior deputy governor Carolyn Wilkins said current conditions are unlikely to open the door for people to pile on more debt, even with the slightly lower rate.

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