The pros and cons of the Bank of Canada’s interest rate cut
Cheaper access could come at a much higher cost down the road.
bank of canada
TORONTO — In slashing its key interest rate to 0.5%, the Bank of Canada is aiming to boost both consumer spending and business investment by providing cheaper access to capital. But the rate cut could also pose some risks to the country’s economy.
Here is a look at some of the positive and negative implications that could stem from the central bank’s announcement:
MORTGAGE DEBT: Variable-rate mortgage holders could get some relief as Canada’s big banks move their prime rates lower. TD Bank was the first out of the gate to announce a reduction in its prime rate, which is used to determine variable-rate mortgages, home equity lines of credit and other kinds of variable-rate borrowing. But the lender only passed on 10 basis points of savings to borrowers, rather than the full 25 basis point cut.
The Royal Bank later decreased its prime lending rate by 15 basis points to 2.7%.
Reduced mortgage rates could cause house prices to soar higher in red-hot markets like Toronto and Vancouver, says Phil Soper, CEO of Royal LePage. That could leave some Canadians struggling to service their debts once interest rates begin to rise.
But Soper says the second consecutive rate cut could also reduce consumer confidence and temper home sales to some extent, thus reducing the impact on consumer borrowing.
INVESTMENTS: People stashing their money in high-interest savings accounts and market-linked GICs – instruments that are both tied to the prime rate – could see lower returns, according to Penelope Graham of RateSupermarket.ca.
“This is really discouraging for savers, because they’re saving their money and they’re getting less of a return back,” says Graham, who recommends exploring alternative avenues such as fixed-rate GICs.
Soami Kohly, fixed income portfolio manager at MFS Investment Management, says the stock market could see a bit of a boost, as the weaker loonie will likely serve as some stimulus for Canadian exports.
The rate cut marked the second time this year that the Bank of Canada has reduced its target for the overnight rate. By slashing it, the central bank is hoping to jump-start the economy by making it cheaper for consumers and companies to borrow money.
In response, the Canadian dollar plunged to a post-recession low. The loonie was down more than a full US cent July 15 to levels not seen since March 2009, when Canada was in the midst of a deep recession.
At one point, Canada’s dollar was worth about 77.29 cents US, down 1.2 cents from the previous close, but had been even lower earlier in the day.
Economists had been split in their predictions about what the Bank of Canada would do, with most, but not all, calling for a rate cut.
“It’s not a true recession, since an employment decline hasn’t joined in with the tumble in output measures, but the GDP decline opened a window for a further ease by a dovishly inclined Bank of Canada governor,” CIBC chief economist Avery Shenfeld said following the bank’s announcement.
In its monetary policy report, the Bank of Canada forecast the economy contracted at an annual pace of 0.5% in the second quarter compared with its April forecast for growth at a pace of 1.8%.
However, the central bank predicted growth at an annual pace of 1.5% in the third quarter, followed by 2.5% in the last three months of the year. That compared with its earlier forecast for growth of 2.8% and 2.5% for the third and fourth quarters respectively.
For all of 2015, the Bank of Canada is now forecasting growth of just 1.1%, down from its earlier forecast of 1.9%.
The bank said several factors point to renewed growth in the third quarter, helped in part by the retroactive child-care benefit cheques Ottawa is poised to send out this month.
Poloz said if matters don’t unfold as expected, the Bank of Canada still has room to move manoeuvre as well as other tools in its monetary policy toolbox.
“If we are disappointed one way or the other, we have room to move,” he said.
© 2015 The Canadian Press