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By Mike Caggeso
The Toronto Stock Exchange gained a whopping 477.22 points yesterday (Tuesday), reversing most of Monday's losses – a 3.93% gain and its best daily performance in five years – after the Bank of Canada cut its main interest rate by a quarter point to 4%.
The Canadian dollar also rose .7% to $1.0282 per U.S. Dollar, a significant gain after hitting a four-month low.
Unlike most rate cut scenarios, Canada's economy is operating above its production capacity and both core and total consumer price index (CPI) inflation are lower than projected in its Monetary Policy Report (MPR) in October.
In this case, the rate cut was primarily a precautionary move – putting up its economic dukes to fend off threats of [and reactions to] a possible U.S. recession.
"Financial market conditions have deteriorated since October, leading to a tightening of credit conditions in industrial countries. Given this, and a deeper, more prolonged decline in the U.S. residential housing sector, the 2008 outlook for the U.S. economy is now significantly weaker than at the time of the October MPR," the bank said in a statement.
Domestic demand remains strong because of rising incomes and commodity prices, the bank said. But effects of a weaker U.S. economy will stunt Canada's exports, and the bank projects that growth in 2008 will be weaker than it projected in October.
"In line with this outlook, the Bank has decided to lower the target for the overnight rate and further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to return inflation to target over the medium term," the bank said.
The rate cut follows suit with U.S. Federal Reserve Chairman Ben Bernanke's rate cut of three-quarters of a point before the markets opened yesterday (Tuesday) as a precaution against free-falling stocks around the world.
"The Bank of Canada's history is it tends to follow the Fed with a lag," Ted Carmichael, chief Canadian economist at J.P. Morgan Securities in Toronto, told Bloomberg. "That's going to be the pattern again this time."
The bank will publish an update to its Monetary Policy Report tomorrow (Thursday). Its next scheduled date for announcing the overnight rate target is Mar. 4.
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