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Bank of Canada prescribes surprise interest rate drop to manage oil slump threat

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January 21, 2015 - 6:23 PM

OTTAWA - Bank of Canada governor Stephen Poloz says the economy has been suffering from the effects of an "oil shock," so he prescribed a remedy: an unexpected interest rate cut.

To deal with the impact of falling oil prices, Poloz lowered Canada's trend setting rate Wednesday from one per cent to 0.75 per cent, a move that blindsided the vast majority of experts.

Many economists were anticipating the central bank would hold off on moving the rate until late 2015 or early 2016, with the next adjustment expected to be a hike.

But Poloz took another route Wednesday, as the central bank called the effect of plummeting crude prices "unambiguously negative" for the oil-exporting country's economy.

"We have an oil-price shock, which will reduce the income flowing into Canada and lead probably to some increase in unemployment overall," Poloz told a news conference after Wednesday's rate announcement.

Until the effects of oil's late-2014 tailspin started to trickle through, Canada appeared to be on the cusp of a promising post-recession rebound — and inching closer to a rate increase.

Still, Poloz said he remained encouraged by signs of economic life, particularly in Canada's non-energy sector, thanks to a low loonie and robust growth in the U.S.

That's where the central banker said his rate-cutting plan comes in.

Poloz's solution aims to buffer the positives still present in the healing Canadian economy from potential damage inflicted by low oil.

The goal is to give businesses, such as manufacturers still hobbled from the 2008-09 downturn, enough time to reinvest in their operations using cheaper credit and, eventually, create jobs.

"We think that the positive trend is underneath the surface, that things are getting stronger," Poloz said.

"I think that this is a setback, it's an interruption if you like, in our path back to where we planned to go. It's delaying things by perhaps as long as a year."

He described the bank's plan as "insurance," a move intended to shorten that delayed recovery.

Poloz also sought to ease potential public fears when asked whether the rate cut signals he's worried about the health of the economy. He said he wouldn't put it quite that way.

"That doesn't mean that there's a really bad thing, or a drastic thing, happening here," Poloz said of the rate reduction.

"For us, it's a more a matter of repositioning the economy in such a way that it fires on all cylinders."

The bank also offered assurances that the rate drop would not increase Canada's high level of household debt.

But it did reiterate the warning that Canadians remain vulnerable to economic shocks due to near record high housing prices and debt.

The bank has blamed the accumulation of debt on the extended period of the already low interest rate of one per cent, which helped propel consumer spending.

However, Bank of Canada senior deputy governor Carolyn Wilkins said Wednesday that current conditions are unlikely to open the door for people to pile on more debt, even with the slightly lower rate.

The bank predicted the oil collapse would lead to a drop in employment and income, especially in energy-rich regions. As a result, it expects less consumption due to a smaller amount of disposable income.

Wilkins credited the oil price climb for boosting the incomes of all Canadians by about seven per cent since 2002.

"What this oil shock does is it reverses some of those gains," she said.

The bank's concerns over the oil slump come as some Canadian industries reel from the sharp plunge in crude prices, which are down more than 55 per cent since June.

The Canadian Association of Petroleum Producers said Wednesday that it expected oilpatch investment to total just $46 billion this year, down from $69 billion in 2014.

The decline in oil prices is also expected to shave billions of dollars from the bottom lines of federal and provincial governments.

Last week, the federal government took the rare step of delaying the budget until at least April, so it could assess the effect of tumbling crude.

In latest monetary policy report, also released Wednesday, the central bank predicted the country's headline inflation rate to temporarily dip to one per cent — below the bank's target range — before climbing back up to two per cent in the second half of the year.

The bank also highlighted persistent problems in Canada's labour market, where it found long-term unemployment was still close to its "post-crisis peak."

It said average hours worked remained low and the proportion of people who could only find part-time work was still high.

The bank predicted the pace of Canada's economic growth — measured by the real gross domestic product — to slow to roughly 1.5 per cent in the first half of 2015 and for the output gap to widen.

The Canadian economy is expected to gather steam in the second half of the year, allowing real GDP growth to average 2.1 per cent in 2015 and 2.4 per cent in 2016.

In its last monetary policy report — in October — the Bank of Canada predicted 2.4 per cent growth for 2015.

The bank's estimates were based on oil prices of US$60 per barrel, well above current levels which remain well under US$50. The report said if oil were to remain close to US$50, real GDP growth would dip to 1.25 per cent in the first half of 2015.

The Bank of Canada is scheduled to make its next interest-rate announcement March 4, while its next monetary policy report is due April 15.

News from © The Canadian Press, 2015
The Canadian Press

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