Citing the rapid rise of the loonie and its impact on economic growth, the Bank of Canada cut its key interest rate by a quarter-point today to 2.50 per cent.
The rate cut was expected by many analysts, given the sudden and strong jump in the dollar, which has hurt exports and held back expansion in the economy.
“Despite stronger global economic growth, the rapid appreciation of the Canadian dollar against the U.S. currency has cut into the overall growth of aggregate demand for Canadian goods and services through weaker exports and increased imports,” the bank said in a statement.
Domestic growth has been more sluggish than expected, demonstrated by persistent low inflation, and the problem could continue into next year, central bankers said.
By lowering its overnight rate, the central bank’s most closely watched policy interest rate, it has set a downward trend for many consumer and business borrowing costs.
Big retail banks tend to change the prime lending rate for their best customers in unison with the central bank’s overnight rate.
This rate cut — the third since July — is designed to boost growth while taking a bit of froth off the soaring loonie.
The currency has jumped by more than 20 per cent since the beginning of 2003 and was trading above 78 cents (U.S.) early last week.
That’s the fastest rise over the shortest time that the dollar has ever experienced, analysts say.
However, as speculation of a rate cut grew in recent days, the Canadian dollar began to cool off a bit and closed Monday at 76.81 cents (U.S.).
Much of the loonie’s growth in the last year has been attributed to a loss of confidence in the U.S. greenback.
But some of its strength has also come from the wide gap between policy interest rates in Canada and the United States, where the key rate is one per cent.
The rate cut today narrows that gap a bit and should lessen demand for the loonie.
It also reduces the bank rate, which used to be the most closely watched rate, by a quarter point to 2.75 per cent.
The bank will elaborate its views on the economy Thursday in its monetary policy report. Its next scheduled rate announcement is March 2.
While many analysts had expected the cut today, they had warned it wasn’t a sure thing because of so many mixed signals in the Canadian economy.
On the positive side, the labour market has been booming, creating more than 200,000 jobs in the final four months of 2003.
That’s good for consumer confidence.
However, inflation has been running below the bank’s two per cent target, suggesting weak demand.
New inflation data is due Thursday. But the latest figures showed the core rate, which excludes volatile food and energy figures, was 1.8 per cent in both October and November.
“As a consequence, the output gap at the end of 2003 appears to be somewhat larger than the bank was expecting,” central bankers said in their statement.
They had predicted growth of close to five per cent in the final quarter of 2003, and while the final figures aren’t in yet, it’s likely to be closer to four per cent.
Analysts had warned that underperformance could be enough to push the bank to trim borrowing costs.
