Bank of Canada follows Fed with coronavirus rate cut

It is “becoming clear” virus will impact growth more than previously expected, central bank says
Bank of Canada facade

The Bank of Canada has lowered its policy rate by 50 basis points, joining several other central banks attempting to stay ahead of the economic impacts of the coronavirus.

The move, which mirrors a surprise action made on March 3 by the Federal Reserve, leaves the central bank’s policy rate at 1.25%. 

“While Canada’s economy has been operating close to potential with inflation on target, the Covid-19 virus is a material negative shock to the Canadian and global outlooks,” the central bank said in its policy statement today (March 4).

Policy-makers left the door open for possible future easing, stating it “stands ready to adjust monetary policy further if required to support economic growth and keep inflation on target”.

The coronavirus has now spread from China to 72 countries, infecting more than 94,000 people. The current death toll worldwide is 3,214 people. Eight new countries – Andorra, Jordan, Latvia, Morocco, Portugal, Saudi Arabia, Senegal and Tunisia – reported cases in the 24 hours prior to 9am London time on March 3, according to the most recent update from the World Health Organisation.

Canada faces 27 confirmed cases but no confirmed deaths, the report shows.

The virus has hit global business activity and disrupted supply chains globally, creating spillover effects on commodity prices and causing the Canadian dollar to depreciate, the central bank said.

Global markets have also reacted to the spread of the virus by repricing risk, causing financial conditions to be less accommodative, it adds.

“It is likely that as the virus spreads, business and consumer confidence will deteriorate, further depressing activity,” the central bank said.

Economic growth slowed towards the end of 2019, from 1.3% quarter-over-quarter growth in the third quarter, to 0.3% in the fourth quarter. In January, the central bank said it expected growth to bounce back to 1.3% for the first quarter of this year, but it is “becoming clear” that it will likely be weaker than anticipated, it said today.

“The outlook is clearly weaker now than it was in January,” it said, noting the drop in the countries’ terms of trade will weigh on income growth if sustained.

Inflation was 2.2% in December, marginally higher than the central bank’s 2% target. It was up from 1.9% in November, which the central bank attributes to higher gasoline prices. Core inflation remained at 2%.

Several central banks have already eased monetary conditions, including those in Australia, China, Malaysia, Thailand and the US. The Group of Seven (G7) said on March 3 its members stood ready to act, so more may follow in the weeks ahead.

More easing to come?

Stephen Brown, senior Canadian economist for Capital Economics, expects the Bank of Canada to follow today’s decision with a further easing in its next monetary policy meeting in April.  

“Given the likelihood that the number of Covid-19 cases will rise rapidly in Canada in the coming weeks and that the incoming economic data, both domestically and internationally, will deteriorate, we expect the bank to follow today’s cut with another 25bp reduction at the next meeting in April,” Brown tells Central Banking.

Brown does not expect, however, the central bank to go any further due to “lingering concerns” that looser policy will boost the “already red-hot housing market”, he says.

The Bank of Canada has recently formally incorporated financial vulnerabilities into its monetary policy decision-making framework though a “growth at risk” measure.

In a recent speech, deputy governor Paul Beaudry said the central bank made the decision in October 2019 not to make a “insurance cut” due to the longer-term implications for financial vulnerabilities.

Shoring up sentiment

Josh Nye, senior economist at Royal Bank of Canada (RBC), says the move is more likely to “shore up” financial market sentiment and support business and consumer sentiment than offset the demand and supply shocks related the virus.

Fed chair Jerome Powell highlighted a similar transmission channel in the press conference following the Fed’s announcement. He said the central bank recognises that lower rates “will not reduce the rate of infection” or “fix a broken supply chain”, but it does believe its action “will prove a meaningful boost to the economy”.

“More specifically, it will support accommodative financial conditions and avoid a tightening of financial conditions, which can weigh on activity, and it will help boost household and business confidence,” Powell said.

Nye says: “It’s the response from other policy-makers, particularly fiscal and health authorities, that could do more to cushion the blow as the coronavirus outbreak intensifies.”

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