Interest Rates

Coronavirus prompts Bank of Canada to slash interest rates for the first time since 2015

By: Zandile Chiwanza on March 4, 2020

For the first time since 2015, the Bank of Canada (BoC) has slashed its overnight interest rate, to 1.25%, largely in response to concerns over the economic impact of the coronavirus disease (COVID-19).

The bank made mention of other economic burdens, such as the CN rail blockades, Ontario teachers strikes, and even winter storms in some regions, but the coronavirus appeared to be the primary concern. 

“COVID-19 virus is a material negative shock to the Canadian and global outlooks, and monetary and fiscal authorities are responding,” the central bank said in Wednesday’s rate announcement — Governor Stephen Poloz's last announcement before his departure in June. 

A majority of economists anticipated that the bank would have no choice but to cut its main interest rate amid a slowing economy as a result of the coronavirus, especially given that the U.S. Federal Reserve made an emergency rate cut just yesterday for the same reason, as did the Reserve Bank of Australia, slashing the country’s interest rates to a record low 0.5%.

Avery Shenfeld, managing director and chief economist of CIBC Capital Markets, said in an email sent prior to today's rate announcement: “While a rate cut is far from an ideal weapon, it couldn’t hurt … Waiting until April, our prior call would look out of synch with the evidence. So we’re looking for a quarter-point cut by the BoC this week, a further cut in April, with a 75 bp reduction in total for the year, expecting the Fed to match that.”

The economic threat of the coronavirus outbreak

As the world grapples with the spread of coronavirus — according to Public Health, 33 Canadians have tested positive for the virus that has killed thousands of people across the globe — the G7 finance ministers and central bank governors vowed in a press statement yesterday to use all “appropriate policy tools” to battle the outbreak. 

While the virus was first detected in China’s Hubei Province, it has now spread globally, and there are fears that the resulting economic slowdown could tip countries into recession.

All eyes were on the BoC to see if the coronavirus would impact its decision today, and it did. The bank identified COVID-19 as a significant “health threat” but also a danger to the economy.

“Business activity in some regions has fallen sharply and supply chains have been disrupted,” the bank’s announcement reads. 

“This has pulled down commodity prices and the Canadian dollar has depreciated. Global markets are reacting to the spread of the virus by repricing risk across a broad set of assets, making financial conditions less accommodative. It is likely that as the virus spreads, business and consumer confidence will deteriorate, further depressing activity.” 

Anti-pipeline blockades dampening economic activity

Coronavirus isn’t the only thing putting a strain on the economy.

Since February 6, cross-country CN rail blockades —done in solidarity with Wet’suwet’en hereditary chiefs, who oppose a Coastal GasLink pipeline project that is set to cross traditional Wet’suwet’en territory — have snarled the country’s freight system. In response, CN announced a shutdown of its operations in Eastern Canada and Via Rail suspended passenger service across most of the country. 

According to the Financial Post, the “blockades have led to 1,000 temporary layoffs of Via Rail workers and propane shortages looming in Eastern Canada. Manufacturers and small businesses have warned of job losses and a sales slowdown if the blockades persist.”

Douglas Porter, chief economist at BMO, told the Post that while “Canada hasn’t really seen long-term damage on their global reputation due to a strike yet, other countries with extremely widespread protests have seen an impact before.” 

Only time will reveal the true effect the blockades have had on the economy. As of yesterday, the Globe and Mail reported that CN plans to recall most of the 450 workers it laid off due to the blockades, even though it will take several weeks to get back to regular operations. 

Is the rate cut a band-aid solution?

There will no doubt be some concern that a rate cut of 50 basis points, while crucial in order to stimulate a slowing economy, poses a risk to already over-leveraged Canadians who might be lured by lower interest rates to borrow more money when they can’t afford it.

For example, in response to today’s announcement, licensed insolvency trustee firm Hoyes Michalos & Associates Inc. tweeted: “Bank of Canada cut the rate today. But just FYI, this will have zero impact on high cost borrowing. Fast financing loans are still going to charge 40% to 60% interest. Credit cards are still going to charge 18% minimum to carry a balance.”

That’s not the only concern. Canadians are already in recession mode.

“Even before Covid-19 fears sparked a global stock market sell-off and a series of blockades brought rail shipments in Canada to a halt, nearly half of Canadians believed the country’s economy was already in recession,” Macleans reported last week, calling it a “psychological recession.”

GDP growth slowed to 0.3% during the fourth quarter of 2019, in line with the Bank’s forecast and both business investment and exports weakened. 

While the bank had a lot to say about coronavirus, there was barely any mention of the housing market, only that “residential investment continued to grow, albeit at a more moderate pace than earlier in the year.”

The bank’s dovish tone in today’s release also signalled that another cut could be necessary. The BoC said it “stands ready to adjust monetary policy further if required to support economic growth and keep inflation on target” and will be monitoring the economic and financial conditions along with other G7 banks.

In an email sent shortly after the announcement, Shenfeld said that today’s move matched expectations and predicts another cut is inevitable.

“The Bank of Canada didn't wait to see the patient ailing before delivering a dose of preventative medicine, but where it goes from here is a matter of epidemiology rather than economic,” he wrote.

“Like the rest of us, they will be watching for news on both the virus and the economy, but it’s reasonable to assume a further 25 bp cut in April, with the rest of this year's story being dependent on which virus scenario plays out. Bonds had a bit of room to rally as the full 50 bps wasn't entirely priced in.”

The next announcement on the overnight rate target will be released on April 15, along with April’s Monetary Policy Report (MPR).

 

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