When OPEC’s supply standoff initiated oil’s price slide last November, few foresaw just how quickly the commodity’s value would plunge. Equally surprising was how rapidly Canada’s economic policy makers reacted with a January rate cut that caught many – including the big banks – off guard. Now, as the next Overnight Lending Rate announcement looms on March 4th, borrowers and economists speculate whether the Bank of Canada has more “economic insurance” in store.
Inflation’s Slump Hikes Chances
The likelihood of another rate cut hovers at 53 per cent according to overnight swap pricing, and worsening economic factors provide additional rationale; oil’s prolonged drop is feared to push inflation levels to negative territory in the first half of the year. In a speech this week, Bank of Canada Deputy Governor Agathe Côté stated the BoC anticipates inflation to fall as low as 0.3 per cent or below in Q2 before recovering moderately to 1.2 per cent by next winter.
Côté affirmed low inflation was a significant contributor to the BoC’s January rate decision, stating, “The cut in policy rate is intended primarily to provide insurance against the downside risks to inflation.” And oil can’t be blamed entirely for inflationary failure. Consumers are simply spending less – even during the busy holiday season – with the lowest December sales numbers reported since 2010.
Jobs are another key ingredient in the monetary policy mix, but performance has been less than robust. Early-month revisions released by Statistics Canada show 2014 job gains were over-reported by a third, driving the unemployment rate to 6.7 per cent from 6.6. With only 121,300 positions added, 2014’s job gain numbers are the smallest since 2009.
A History of Cuts
Precedent shows that when the Bank of Canada goes into rate-slashing mode, it doesn’t stop at one; the last series extended from 2007 to 2010, and saw the central rate drop from 4.50 per cent to a low of 0.25 in April of 2009. The purpose of these cuts was to provide a buffer against the global recession, encouraging Canadians to continue borrowing and avoiding a credit crunch. Once Canada began to recover, the Bank edged the rate back up to an eventual one per cent in September 2010, where it remained until this January.
It’s not clear whether today’s economic conditions warrant that drastic a drop; while oil’s fallout will have significant implications for many aspects of our economy, the Bank of Canada has expressed optimism that prices will rebound. As stated in the January rate announcement, “The Bank’s base-case projection assumes oil prices around US$60 per barrel. Prices are currently lower but our belief is that prices over the medium term are likely to be higher.”
Will Banks Cut Prime Again?
The reality is there is simply less room for policy makers and banks to manoeuvre in today’s ultra-low borrowing environment. Rates have been historically low for the past two years. Hyper-competitive mortgage pricing has become the norm for today’s home buyer, with today’s best five-year fixed options in the 2.5 per cent range. With the traditionally hot spring buying season just around the corner, lenders are sure to race with their discounts, but it’s just a 250-basis point drop to absolute zero.
What will be interesting is how quickly Canada’s FIs react to a March rate cut. They were infamously slow to adjust their Prime rates in response to the BoC’s January mandate, taking up to a full week to implement a partial 15 per cent discount. While they are certainly cautious to protect their profit margins amid an already razor-thin spread, it can be argued they simply didn’t foresee the BoC’s last surprise move. Perhaps they’ll be more nimble this time around – especially as customers are keen to see the discount passed on to them.