Bank of Canada opts for aggressive interest rate cut

The Bank of Canada on Tuesday chopped its key overnight lending rate by half a percentage point to 3.5 per cent to prevent U.S. economic weakness from spilling over into Canada.

Further rate cuts 'likely'

The Bank of Canada on Tuesday chopped its key overnight lending rate by half a percentage point to 3.5 per cent to prevent U.S. economic weakness from spilling over into this country.

It's the first time the Bank of Canada has cut its key rate by more than a quarter of a percentage point in more than six years.

Analysts had been divided over how much the Bank of Canada would trim rates. Many thought the bank would opt for a half-point cut. Others thought a quarter-percentage-point cut would be more likely, given that domestic demand in the Canadian economy is still strong.

But the central bank said the prospects for Canada's economy have obviously weakened in the last two months.

"There are clear signs that the U.S. economy is likely to experience a deeper and more prolonged slowdown than had been projected in January," the bank said in a statement. 

"The deterioration in economic and financial conditions in the United States can be expected to have significant spillover effects on the global economy."

The Bank of Canada also signalled that further interest rate cuts are probable.

"Further monetary stimulus is likely to be required in the near term to keep aggregate supply, and demand in balance and to achieve the two per cent inflation target over the medium term." 

The bank said the slumping U.S. residential housing market is hurting other parts of the U.S economy and leading to a further tightening in credit conditions. As a result, it said the downside risks to Canada's economy are intensifying.

"The bank now judges that the balance of risks around its January projection for inflation has clearly shifted to the downside," the bank said.

Bank prime rate falls to 5.25% 

It took the big banks more than five hours to start matching the Bank of Canada's rate cut with a half-percentage point cut in their prime lending rates. TD Bank was the first to lower its prime rate to 5.25 per cent, from 5.75 per cent, effective Wednesday. Royal Bank, CIBC, Scotiabank, BMO and Laurential Bank followed soon after.

The prime rate is what banks charge their best customers and serves as a benchmark for a whole range of lending rates for variable mortgages and floating interest rate loans. 

The Canadian dollar, which had been trading slightly higher just before the rate announcement, quickly fell on news of the half-point cut. The loonie fell more than two-thirds of a cent to close at $1.0049 cents US.   

On Monday, Statistics Canada reported that the Canadian economy contracted by a weaker-than-expected 0.7 per cent in December.

Fourth-quarter growth came in at just 0.8 per cent on an annual basis — the weakest since 2003.

Tuesday's aggressive rate cut was the first policy move presided over by the new Bank of Canada governor, Mark Carney. He took over from David Dodge, who retired at the end of January.