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Is Canada ready for negative rates?

Negative interest rates are on the cards for Canada, its central governor said Tuesday, as the country grapples with low inflation and sluggish growth rates after falling into a technical recession earlier this year.

Speaking in Toronto, Bank of Canada (BoC) Governor Stephen Poloz said the odds that the bank could drop its benchmark interest rate below zero have increased since 2009 — back when it originally said it couldn't see rates lower than 0.25 percent.

Stephen Poloz, governor of the Bank of Canada.
Cole Burston | Bloomberg | Getty Images
Stephen Poloz, governor of the Bank of Canada.

The BoC already cut its benchmark rate twice this year, first from 1 percent to 0.75 percent in January, and then to 0.5 percent in July.

Now, rates as low as minus 0.5 percent may be considered to help reach the bank's 2 percent inflation target, Poloz explained. The annual inflation rate was last recorded at 1 percent in October, holding steady from a month earlier.

His comments came as the Canadian loonie fell to an 11-year low of $0.74 Tuesday, as low oil prices dragged on the resource-dependent economy.

Negative interest rates are just one of the unconventional monetary policies that Poloz said sits in the bank's "toolkit," alongside forward guidance for markets, large scale asset purchases, and funding for credit programs that aim to increase lending to households and businesses.

After seeing markets adapt to negative rates set by the European Central Bank and Swiss National Bank, Poloz said the BoC "is now confident that Canadian financial markets could also function in a negative interest rate environment."

"I certainly hope we won't ever have to use these tools. However, in an uncertain world, a central bank has to be prepared for all eventualities," Poloz explained.

Negative interest rates are meant to spur spending, investment and lending, as it essentially costs money to keep cash in the bank.

However, a research note released Wednesday showed RBC Economics Research was confident about Canada's prospects, saying that consumer spending and exports would boost growth, and help the economy to expand at an "above-potential pace" next year.

"This will likely prompt the Bank to reverse the 50 basis points of interest rate cuts implemented in 2015, although it will likely take until the fourth quarter of 2016 for this to occur," the note, led by RBC Economics Research's Deputy Chief Economist Dawn Desjardins, said.

Poloz espoused similar optimism, adding that sectors outside of the resource sector were gaining momentum.

"This is all taking longer than we imagined back in 2008, but our judgment is that our economy can get back to full capacity with inflation sustainably on target around mid-2017," he said.