BoC cuts overnight rate 1/4 percentage point to 2 1/2 per cent
Strong loonie, low inflation, weak demand leave door open for further cuts down the road

By Peter Diekmeyer -

The Bank of Canada lowered its target rate by 1/4 of a percentage point on January 20th to 2 1/2%. The operating band for the overnight rate was also cut and the bank rate now stands at 2 3/4 per cent.

After the central bank's announcement, Canada's big banks followed suit cutting their prime lending rates to 4.25 per cent. The Royal Bank of Canada was first out of the gates, followed by the CIBC, National Bank of Canada, Bank of Nova Scotia, Toronto Dominion Bank and Bank of Montreal.

In a prepared statement the bank cited several reasons for the cut including weak inflation, a strong Canadian dollar and weak domestic demand.

"Both core and total CPI inflation remain below the 2 per cent target. Underlying price pressures and the presence of spare capacity point to a core rate of inflation that will likely persist below target late into 2005," the central bank said in the statement announcing its rate move.

The strong loonie, which has jumped by almost 20 per cent against the American greenback during the past year remains a key cause of concern for the Bank of Canada.

"Despite stronger global economic growth, the rapid appreciation of the Canadian dollar against the U.S. currency has cut into overall growth of aggregate demand for Canadian goods and services, through weaker exports and increased imports," said the central bank.

Effect on consumer loans

Although big Canadian banks tend to more their prime rates in tandem with Bank of Canada announcements, consumer loans are less likely to be affected. These are closer tied to the bond market, as are the rates banks pay on deposits and GICs.

For example national Bank of Canada kept most of its fixed-rate term mortgage loans unchanged as a result of the Bank of Canada move, but cut five year variable rates by 25 basis points from 4.25% to 4.0%.

The bank's target rate is its primary monetary policy tool. The rate signals the country's key financial institutions the average rate they are expected to charge each other for overnight loans.

Like the U.S. Federal Reserve Board, the Bank of Canada announces its rate setting decisions eight times a year.

These are made by means of prepared statements, which usually includes analysis about where the BoC thinks that the economy and inflation are headed. These pronouncements are scoured and parsed for hidden meaning by economists for indications of future central bank decisions.

The Canadian economy has been performing sluggishly lately with real GDP edging up only 1.1 per cent in the third quarter.

The modest growth rate reflected sharp inventory corrections by manufacturers and retailers, the August power blackout in Ontario and the ban in Canadian beef imports by several countries due to the discovery of a case of Mad Cow Disease at an Alberta farm

In its Monetary Policy Report Update, which was released the day after its rate announcement, the Bank of Canada revised its 2004 growth forecast downward by half a percentage point to 4.0 per cent.

The bank also predicted that core inflation will fall below 1.5 per cent in early 2004. The slackness in product and labor demand should keep price pressures down in the near term. But prices are expected to rise gradually as the output gap closes in the coming quarters as the economy picks up steam, gradually moving back up to 2 per cent by the end of 2005.

The weakness in the Canadian economy coupled with the continued low inflation scenario leaves the door open for the BoC to make further rate cuts down the road

The next Bank of Canada rate announcement is scheduled for March 2nd,


Schedule of upcoming Bank of Canada rate announcements:

January 20th, 2004
March 2nd, 2004
April 13th, 2004
June 8th, 2004
July 20th, 2004
September 8th, 2004
October 19th, 2004
December 7th, 2004

Previous Bank of Canada action:

Date Action Overnight rate (after announcement)

December 2nd, 2003 No change 2 3/4%
October 15th, 2003 No change 2 3/4%
September 3, 2003 - 1/4% 2 3/4%
July 15, 2003 - 1/4% 3%
April 15th, 2003 +1/4% 3 1/4%
March 3rd, 2003 +1/4% 3%




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