Immediate worry of COVID-19 spurred Bank of Canada rate cut [UPDATED]
Worries about the downside risks to the economy outweighed continuing concerns about financial vulnerabilities in Canada
Canada’s central bank was leaning towards cutting its trend-setting interest rate this week before the novel coronavirus pushed it to take a more dramatic step to get ahead of the shock the outbreak will have on the economy, Bank of Canada governor Stephen Poloz says.
Poloz said March 5 the bank wanted to cut rates “in a decisive manner” to have a cushion for Canada’s economy against the effects of COVID-19, similar to when oil prices collapsed about five years ago.
He said the immediate effects the virus will have on business investment and consumer spending meant the downside risks to the economy today outweighed continuing concerns that cutting rates would fan financial vulnerabilities in Canada, such as high household debt.
On March 4, the bank cut its key rate target to 1.25% — the first cut since the summer of 2015, which brought the rate to its lowest level since early 2018.
“We made a decision this week not to dip our toe in the water, but rather to make a decisive and clear move so that people get immediate impact through mortgage renewals and cash flow for those with flexible mortgages,” Poloz said in a news conference in Toronto.
“We believe we’ve done a lot there to cushion a blow. We don’t know how big the blow might be, so we’ll be looking at ways to figure out how big that blow might be and how long it might last.”
Poloz left the door open to further rate cuts should circumstances require it.
During a luncheon speech, he said the economy may snap back if things quickly return to normal, but warned the situation could be more persistent and include longer-term layoffs.
“It underscores that the need for further policy steps is going to depend heavily on which of several possible paths COVID-19 and its economic consequences take,” CIBC chief economist Avery Shenfeld said in a note about the speech.
Weakened commodity prices related to the outbreak will add to tough times in oil-producing regions, Poloz said, before likely spreading the financial hit elsewhere as people affected “spend less money on everything.” He also said a drop in rates could stabilize the housing market, instead of contributing to froth, if a slide in consumer confidence reduces activity.
On the other hand, a rate cut could be passed along to high-interest savings accounts and other fixed-income investments that would lower monthly cash flow for retirees, said James Laird, co-founder of Rathub.ca.
Many of the implications and responses to COVID-19 lie beyond the bank’s control, Poloz said, such as if production is disrupted, or if people need to stay home from work. He spoke about strengthening the labour market and suggested federal policy-makers find ways to remove hurdles that make it hard for workers to match up with available positions, of which there are half a million in the country.
The unknowns about the virus have rattled financial markets, disrupted global supply chains and shuttered factories in China, where the outbreak began, that many Canadian businesses rely on for inventories. Worries about catching COVID-19 could also depress consumer spending, which the economy relies on.
Add into the mix a slowdown in the fourth quarter of 2019, rail blockades, unusual winter weather and job action by Ontario teachers and the outlook for growth over the first quarter of this year is weaker than previously forecasted, and could easily affect the second quarter, Poloz said.
The missing piece in Poloz’s speech was the role federal fiscal policy can play in mitigating the economic effects of the virus, said Brian DePratto, senior economist at TD Economics. In a note, he said Poloz has in the past spoken about the relationship between fiscal policy and monetary easing, “which would imply that there is some scale of fiscal response that could obviate further monetary easing.”
The spotlight will be on federal Finance Minister Bill Morneau on March 6 when he is scheduled to deliver a speech about the economy.