But stocks rally after Bank of Canada move sparked by oil price crash, federal defict fears
OTTAWA— Jobs will be harder to find and the economy will slow as the oil price crash bites in coming months, the Bank of Canada said as it sought to cushion the blow by unexpectedly lowering its key interest rate.
In a signal that fallout from sliding oil prices could be much worse than expected, the central bank reduced its overnight interest rate to 0.75 per cent from 1 per cent.
The Bank of Canada uses the key rate to influence the borrowing costs that commercial banks charge business and consumers, which allows the central bank to boost economic growth if there is a risk of sharp downturn.
“We decided that it was appropriate to take out some insurance against that downside risk in the form of a lower interest rate profile,” bank governor Stephen Poloz said after the rate announcement.
It likely means lower mortgage costs for homebuyers and a longer grace period — probably until next year at least — before mortgage holders are squeezed when the Bank of Canada begins to drive up borrowing costs to head off a burst of inflation.
The bank had not altered its key interest rate since September 2010 and the surprise decision went off like a bomb in financial markets. The prospect of increased business investment and commercial activity from lower rates prompted a sharp rally on the Toronto Stock Exchange. The S&P/TSX composite index jumped 251.98 points to 14,560.42.
But the Canadian dollar plummeted, closing on exchange markets at 81.07 (U.S.) cents, down1.53 cents from its close on Tuesday.
“The dollar has tanked. There is a run to the U.S. dollar,” Rahim Madhavji of Knightsbridge Foreign Exchange wrote in a research note. The oil price slide is hammering the economy, Poloz said. He predicted growth will stumble to 1.5 per cent in the first half of this year. For 2015 as a whole, the bank now predicts growth of 2.1per cent, well below its previous forecast of 2.4 per cent.
While Poloz’s move may help the economy, in the short run it could increase pressure on Prime Minister Stephen Harper’s government to revise its economic approach. The strategy currently hinges on eliminating the budget deficit to open the way for $5 billion a year in new spending and tax breaks for families, particularly a controversial plan to let spouses split income for tax purposes. Only about 15 per cent of families would benefit from this $2-billion annual measure, and it has been sharply criticized as a waste of valuable financial resources.
Taking into account the new spending announcements by Harper in the fall, falling oil prices put Ottawa in danger of running another budget deficit in 2015 instead of meeting its claim that the books will be balanced this year, economists say.
Thrown off course by the oil shock, Finance Minister Joe Oliver took the rare step last week of rescheduling the 2015 budget announcement from the usual February-March time slot until April at the earliest.
“This rate cut shows that the Bank of Canada believes the Canadian economy is facing more trouble than the Conservatives are admitting,” NDP finance critic Nathan Cullen said.
“We need to make sure that the government’s priority is focused on creating growth and jobs for the middle class,” Liberal Leader Justin Trudeau told reporters.
Canadian Labour Congress economist Angella MacEwan said Poloz appears to have felt he had to move to stimulate the economy because Oliver had no plan to do so.
“The bank was listening to what the federal government was saying in response to what the bank saw as a huge impact on the Canadian economy and felt that they (the central bank) had to step in and take some action,” she told the Star.
The bank noted lower petroleum costs will have a different impact in different sections of the country. Economists have said the Ontario economy should pick up.
Poloz acknowledged lower borrowing costs may worsen Canada’s record level of household debt. But he said the need to stabilize the economy in the long run outweighed the risk of financial instability in the household sector.
Oliver said he doesn’t comment on Bank of Canada decisions but added in a statement: “As we’ve always said, Canada is not immune to the economic challenges and decisions made beyond our borders. That is why our government continues our focus on jobs and economic growth. Our plan is working, with one of the strongest job and growth records in the G7 group of countries.”
Poloz said the economy had been showing signs of growth before oil prices dived. “We are beginning to see the anticipated sequence of increased foreign demand, stronger exports, improved business confidence and investment and employment growth.”
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