Bank of Canada in shock rate cut amid oil slump

Joe Oliver, Canada's finance minister.
Jin Lee | Bloomberg | Getty Images
Joe Oliver, Canada's finance minister.

In a shock move, the Bank of Canada cut its benchmark rate on Wednesday to counter the effects of cheaper oil on economic growth and inflation and to try to prevent financial instability that could result from a vulnerable housing market.

Ending the longest period of unchanged rates since 1950, the central bank cut the overnight rate to 0.75 percent from 1 percent, where it had been since September 2010, and it dramatically slashed the inflation and growth profile for the coming year.

"The considerably lower profile for oil prices will be unambiguously negative for the Canadian economy in 2015 and subsequent years," the central bank said in its quarterly Monetary Policy Report.

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Speaking at the World Economic Forum in Davis, Canadian Finance Minister Joe Oliver said that while he couldn't comment on the decisionhe said the country's "economy overall is doing quite well."

"No there is no crisis," he said at Davos, adding that Canada is going to experience growth close to that of the other G-7 nations.

The decline in oil has been an external shock, Oliver said, adding that the country is expected to have a balanced budget for the year ahead.

"It's critically important that we remain fiscally strong and fortunately we are," he said.

The central bank acknowledged that household imbalances remained high and were expected to edge up in the near term, and signaled that it needed to cut rates "to provide insurance" against financial stability risks and risks of lower inflation.

Lower interest rates could have the effect of exacerbating the hot housing market in Toronto and elsewhere, but the bank's move suggested it was more concerned that the oil price collapse might trigger a housing price crash.

"A soft landing in the housing sector continues to be the most likely scenario," the bank said, adding however that a possible "disorderly unwinding" of household imbalances could have sizeable negative effects on the economy and inflation.

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Analysts had expected the bank to cut its growth and inflation forecasts but had predicted that the bank's next move would be a rate hike, in the fourth quarter of this year or early next year. Interest rate swaps, however, had begun pricing in a small chance of a rate cut as early as Wednesday.

The economy will only grow by 1.5 percent in the first half of 2015, less than the 2.4 percent predicted in October, and thus the output gap will widen, the bank forecast. It cut its 2015 growth outlook to 2.1 percent from 2.4 percent, compared with the International Monetary Fund's prediction earlier this week of 2.3 percent.

The bank pushed back the time frame for when the economy would reach full capacity to the end of 2016 from the second half of 2016.

The most dramatic effect of low oil will be on overall inflation, which it sees below the central bank's target range of 1 to 3 percent for most of 2015 and as low as 0.3 percent in the second quarter.