Bank of Canada cuts rates as coronavirus delivers ‘negative shock’

Thegloebandmail.com
March 5, 2020
Matt Lundy and Bill Curry

The Bank of Canada cut its benchmark interest rate on Wednesday and Ottawa moved to strengthen its response to the new coronavirus outbreak that has roiled stock markets and threatens global economic growth.

The central bank matched an emergency cut from the U.S. Federal Reserve the previous day in response to growing economic concerns about the outbreak that has spread to more than 80 countries.

In Ottawa, Deputy Prime Minister Chrystia Freeland chaired the first meeting of a cabinet committee to address Canada’s response to the coronavirus. The eight-member group has a mandate to monitor both the health and economic impacts of the virus and to consider “all possible measures” to prevent and limit its spread in Canada.

The central bank trimmed its overnight lending rate by half a percentage point to 1.25 per cent, echoing a 50-basis-point cut the U.S. Federal Reserve unveiled Tuesday. It was the Bank of Canada’s largest rate cut since 2009 and its first in more than four years.

The bank also signalled the potential for additional rate cuts to mitigate the “material negative shock” that COVID-19 poses to the economy.

“Before the outbreak, the global economy was showing signs of stabilizing,” the bank said in a statement. “However, COVID-19 represents a significant health threat to people in a growing number of countries. In consequence, business activity in some regions has fallen sharply and supply chains have been disrupted.”

Canada’s major banks moved later Wednesday to reduce their prime lending rates from 3.95 per cent to 3.45 per cent -- a reduction of 50 basis points, consistent with the central bank’s rate cut. A lower prime rate, which forms the basis for most variable-rate loans, will immediately lower borrowing costs for the banks’ clients.

There are 34 cases of COVID-19 confirmed in Canada as of Wednesday evening. At this point, all of the cases in Canada can be traced directly to international travel to a handful of countries, including China, Iran and Egypt.

Public-health officials say they expect the case numbers will increase and that it is likely person-to-person transmission within communities will start to occur in the coming days or weeks.

As coronavirus spreads, the Bank of Canada said it’s likely “business and consumer confidence will deteriorate," weighing on economic activity. Already, COVID-19 has resulted in weaker commodity prices, a depreciation of the Canadian dollar and mounting disruptions across a range of sectors as some companies curtail their operations and cut back on employee travel.

Further central bank action could be delivered next month: As of Wednesday afternoon, there was a 67-per-cent chance of a rate cut at the Bank of Canada’s April 15 announcement, based on derivatives trading.

However, the consensus view on Bay Street and Wall Street is that monetary easing alone is insufficient for the challenge ahead.

“[Rate cuts] are not there to solve the problem. They are there to provide a cushion underneath the fall,” said Frances Donald, chief economist at Manulife Asset Management. “It is truly fiscal policy that is better suited toward stemming the worst of this issue. The baton has now been passed from central banks to governments.”

Finance Minister Bill Morneau, who is a member of the new cabinet committee, hosted a conference call Wednesday with his federal and provincial counterparts to discuss the economic implications of the virus.

The U.S. House of Representatives passed an US$8.3-billion emergency spending package on Wednesday aimed at bolstering the country’s virus response and developing treatments. Further, Treasury Secretary Steven Mnuchin has pointed to support for small business and higher infrastructure spending as potential fiscal measures that Washington could adopt.

Opinion: Federal Reserve’s interest rate slash provokes rather than pacifies investors’ anxiety

Toronto-Dominion Bank chief economist Beata Caranci suggested fiscal stimulus could take the form of targeted tax breaks for hard-hit industries and individuals.

“It doesn’t need to be a blanket approach,” she said. “It needs to be really thoughtful, and most importantly, it needs to be swift. This is not something you want to be debating for months at a time.”

Stocks climbed higher on Wednesday, rebounding from Tuesday’s losses. The S&P 500 finished the session up 4.2 per cent; the Dow Jones Industrial Average rose 4.5 per cent; and Canada’s S&P/TSX Composite increased 2.2 per cent.

Early in Wednesday’s session, investors fled to safety in the bond market. Bond yields, which move opposite to prices, have been tumbling of late, a sign that investors are increasingly pessimistic about economic growth potential. Shortly after the BoC decision, Canada’s 10-year government bond yield dropped to a record low of 0.86 per cent, one day after the 10-year U.S. Treasury fell below 1 per cent for the first time ever.

Moreover, Canada’s five-year bond yield -- which influences the direction of mortgage rates -- briefly fell below 0.8 per cent, its lowest point since late 2016.

The Bank of Canada’s statement was notable for not mentioning household-debt levels, which have been a perennial concern of the bank in its decision-making.

“The benefit to cutting interest rates outweighs the costs,” Ms. Donald said. “While we’re concerned about debt levels and housing affordability in the near term, we likely need to be more concerned about job losses and an economic recession. The Bank of Canada is choosing the lesser of two evils for now.”

The Canadian economy nearly ground to a halt in the final quarter of 2019, before coronavirus spread throughout the world. However, the BoC said it’s not solely COVID-19 weighing on the domestic outlook.

“In addition, rail line blockades, strikes by Ontario teachers and winter storms in some regions are dampening economic activity in the first quarter,” the bank said. “In light of all these developments, the outlook is clearly weaker now than it was in January.”