Bank of Canada Cuts Rates 50 bps to Restore “Financial Market Functionality”
For the third time in three weeks, the Bank of Canada lowered its target rate by 50 bps. This was an unscheduled rate decision that leaves the overnight rate at 0.25%. This moves puts rates at the Bank of Canada’s effective lower bound. This move is intended to provide support to the Canadian financial system during the COVID-19 outbreak.
There have been signs of strain in the commercial and Government securities markets. This strain forced Governor Poloz to engage in a fresh round of quantitative easing. The Governing Council has been meeting daily during this pandemic. Liquidity in the financial markets is considered essential during these trying times. Large-scale purchases of financial assets seek to improve the functionality of the financial markets.
Liquidity Is Drying Up
Credit risk spreads have widened sharply during the last two weeks. Canadians are moving to safety in the form of cash. Liquidity has dried up in all areas of the financial markets. Canadian Mortgage-Back Securities (CMB’s) and GoC T-bills and bonds have faced challenges. Short-term financing for businesses has become nonfunctional. The Bank of Canada is making large purchases of assets in illiquid markets to improve markets across the yield curve. This isn’t an attempt to change the shape of the curve, although, they may attempt that in the future.
At the press conference today, Senior Deputy Governor Wilkins refrained from speculating what other measures the Bank might take in the future. When asked, “Where is the bottom?” She responded, “That depends on the resolution of the Covid-19 health issues.”
The Bank of Canada’s next policy meeting is set for April 15th, 2020. We can expect a full update on the economic outlook in its Monetary Policy Report. Governor Poloz stressed the difficulty in assessing the damage to the Canadian economy. The Bank’s rate cuts have reduced monthly payments for anyone with floating debt.
The drop in oil prices alone would have been enough reason for the Bank of Canada to lower rates. The COVID-19 pandemic has magnified and intensified the situation. Monetary policy can’t cure the pandemic but aims the cushion the economic blow facing many Canadians. The overnight rate of 0.25% is consistent with market rates along the yield curve.
A constant concern is the high level of household debt. Monetary easing helps to bridge the gap until the pandemic eases. The housing market is no longer a point of concern as it pertains to excessive borrowing by cash-strapped households.
Are Negative Interest Rates A Possibility?
As uncertainty increases, the Bank of Canada is not contemplating negative interest rates. Monetary policy tools are almost exhausted given how low interest rates currently sit. With most businesses closed, lower interest rates will not spur consumers to get out and spend money.
The Bank of Canada will continue its large-scale purchases until liquidity improves. The Bank can do this in virtually unlimited quantities as it sees fit. Policymakers are also focusing on the post-pandemic period. The goal is to set the foundation for growth when the economy resumes normal functioning.
In times like these, the fiscal stimulus is necessary. The newly introduced Canada Emergency Response Benefit (CERB) aims to help people facing mass layoffs. Canadians who qualify can receive $2000 / month for 4 months as a taxable benefit.
The loonie has fallen sharply as oil prices decline. Canada is getting a double whammy between the oil price crash and the COVID-19 pandemic.
The economic pain is just getting started in Canada. You can expect the Bank of Canada to monitor the situation closely and act accordingly. These are uncertain times and I’m here to answer all of your questions. Please contact me at 778-558-5159 if you have any questions.