Bank of Canada takes interest rates to floor

OTTAWA — The Bank of Canada has pegged its key policy interest rate to the lowest level practical — probably for more than a year — in expectation of a deepening recession, but the new glum outlook was disputed Tuesday by Finance Minister Jim Flaherty.

OTTAWA — The Bank of Canada has pegged its key policy interest rate to the lowest level practical — probably for more than a year — in expectation of a deepening recession, but the new glum outlook was disputed Tuesday by Finance Minister Jim Flaherty.

“I’m comfortable with our projections. The Bank of Canada has changed theirs, but my projections are the projections we put in the budget,” Flaherty said in rejecting opposition calls for more stimulus spending.

“I’m staying with our budget projection. We’re on track,” he said after the central bank had halved the overnight interest rate to 0.25 per cent.

The apparent divergence of views comes after close co-operation between the Finance Department and the Bank of Canada so far during the current crisis.

It was not clear whether it marked a fundamental difference about the economy or whether the finance minister was attempting to hold off demands that he re-open his budget that only started taking effect at the start of the fiscal year three weeks ago, on April 1.

But the difference — if it exists — is substantial and if the Bank of Canada proves correct, will have profound repercussions for the government’s books.

The new forecast from the central bank of a three per cent economic retreat this year is half a point weaker than what parliamentary budget officer Kevin Page said last month would add at least $19 billion to Ottawa’s deficit over the next two years.

Both the bank and the government had made their calculations in January in expectations the economy would shrink 1.2 per cent, which now looks like boom times by comparison.

Conceding it had miscalculated in January, the central bank said it will almost certainly have to keep its overnight rate at the “the effective lower bound for the rate” until mid-2010.

Such historically cheap money is needed, it said, because the economy will do much worse this year, but also next, growing by 2.5 per cent as opposed to the 3.8 per cent it had earlier envisioned.

Flaherty said Carney’s original expectation for 2010 was “overly optimistic,” but he was sticking to the budget projection for 2009, although most economists see shrinkage of at least double the rate.

“The minister is making a mistake,” NDP finance critic Thomas Mulcair declared as his party called for a second stimulus package beyond the $40 billion introduced in the January budget.

“More is needed to help the Canadian economy now,” Mulcair said. “We’ve simply bled out far too many jobs.”

Prime Minister Stephen Harper left open the possibility of doing more to stimulate the economy.

“I think it’s important to note that our economic action plan did provide a significantly larger stimulus package than the International Monetary Fund was asking for, and one that we think is fairly robust in handling changing economic circumstances,” Harper said during a visit to Jamaica.

“But obviously we will continue to examine the situation, and particularly the employment situation, and we will make adjustments where necessary.”

Flaherty said the stimulus spending only began with the fiscal year starting in April and there will be a clearer view of how it is working in the summer.

Following the Bank of Canada’s rate-cutting decision, the commercial banks quickly lowered their prime lending rate.

They were led by Bank of Montreal (TSX:BMO) which said less than two minutes after the central bank’s announcement that prime, the benchmark for variable-rate mortgages and other loans, was dropping by a quarter-point to 2.25 per cent. Some fixed mortgage rates were also trimmed.

Carney will make a closely watched policy statement Thursday and is widely expected to detail plans for so-called quantitative easing — increasing the money supply through central bank purchases of bonds and other assets from commercial lenders, increasing their reserves.

TD Bank chief economist Don Drummond predicted that this next step will be modest, however, and will bring to a close Ottawa’s attempts to spark the domestic economy.

“Now our fate is cast with the prospects of recovery in the world and U.S. economy,” said Drummond.

According to the Bank of Canada, conditions have deteriorated significantly since the beginning of the year as a result of a global slump that has “intensified” and deteriorating credit conditions “have spread quickly through trade, financial and confidence levels.”

As a result, Carney has basically thrown out the playbook he outlined in January.

Now the bank says the economy won’t stop falling until at least the fourth quarter, in line with projections by the Organization for Economic Co-operation and Development and a growing number of private-sector economists.

It also is more reflective of an economy that has shed 270,000 since January.

Carney remains a relative optimist with his prediction of a bounce-back of 2.5 per cent next year. While lower than his previous prediction of 3.8 per cent growth in 2010, it is still far above the OECD’s forecast of 0.3 per cent.

Economists at the Bank of Nova Scotia termed the central bank’s revised forecast a “significant mid-course correction … and one that is on the mark across the board.”

Meanwhile, the central bank sees no danger of inflation — in fact, it predicts prices will drop at a 0.8 per cent rate in the third quarter and not return to its two per cent target before the third quarter of 2011.

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