On Hold For a Year... We Promise (maybe?)

The Bank of Canada cut its rate in half today, to 0.25%, "which [it] judges to be the effective lower bound for that rate". Unlike the Fed, it did not set a range of 0-0.25; but it's not quite just a straight-up decrease of 0.25%, either. This is because the Bank did not reduce the deposit rate as it usually does when it drops its target overnight rate, so the former remains at 0.25% as well. So, as outlined in its new operating framework, the operating band has been reduced to 0.25% (i.e. from 0.25% to 0.50%) rather than 0.50% previously (yesterday it was 0.25% to 0.75%), with the target now set at the lower bound (0.25%) as opposed to the mid-point of the range (as had been the case). So, all in, this is supposed to be a rate cut of 25bps, but it might be something a bit less than 25 (given the constriction of the band and the unchanged lower bound).

What I find most interesting is not that they say it "commits to hold current policy rate until the end of the second quarter of 2010" (its making this guidance explicit "so as to influence rates at longer maturities"), but that it preceded that with "conditional on the inflation outlook". So, its a non-promise promise. In any case, the only reason they'd deviate from the promise is if inflation surprises to the upside from their current expectations.

As of January's MPR Update, the Bank of Canada expected Canadian growth to be -1.2% this year and +3.8% in 2010. They've admitted (informally) before now that the recession will be deeper than anticipated; they've now put numbers to that. Their new forecast is for -3.0% this year and +2.5% next year (i.e. a smaller rebound off an even lower base), with the start of the recovery delayed until the fourth quarter. The Bank believes we'll have to wait until the third quarter of 2011 to get back to productive capacity, even though they've revised down their estimate of potential growth.

The inflation outlook hasn't changed much, presumably due to the fact that not only has forecast growth been ratcheted down, but so has potential growth. Core inflation is still expected (as in January) to diminish all this year and return to the 2% target in Q3/2011 (instead of the more nebulous "mid-2011"). Headline is expected to trough at -0.8 in this year's third quarter (they said -1.0 in January), before also returning to target at the same time as core. Its hard to know how much these return-to-target assumptions are predicated on their 4.7% GDP growth forecast for 2011. The Bank admits that the risks to inflation remain tilted to the downside (albeit slightly).

The Bank insists that it retains "considerable flexibility in the conduct of monetary policy" despite the low level of interest rates. But we'll have to wait for Thursday's MPR to get a full outline of what that flexibility entails, in terms of quantitative and/or credit easing.