Tuesday, December 04, 2007

RBC Economics Daily - Bank of Canada rate announcement - December 4, 2007

Bank of Canada cuts policy rate by 25 basis points

The Bank of Canada cut the overnight rate by 25 basis points to 4.25% highlighting the growing downside risks to the inflation outlook due to the global financial market volatility. The Bank said that both CPI inflation and core inflation in October came in below their forecasts and that they now expect inflation to be lower than their October projection for the next several months.

Highlights

  • Bank of Canada cut overnight rate to 4.25%
  • Bank flags downside risks and highlights that inflation rates below their expectation

The Bank cited increased risks to the outlook for Canadian exports on the prospect of slower US economy (due to the housing market) and cited a tightening in credit conditions globally as increasing the downside risks to their inflation outlook. The Bank highlighted that the currency is trading closer to the 98 US cents assumed in their October forecast having weakened from its highest level.

Pressure in financial markets has led to a further tightening in credit conditions, the Bank said. However, strong domestic demand kept the economy operating above its production potential in the third quarter producing residual upside risks to the inflation projection.

Today's press release indicates that policymakers are increasingly nervous about the impact of the global financial market turmoil on the outlook for growth and inflation and sets up for additional easing should these conditions persist in 2008. Our view that Canada's economy, like its US counterpart, is headed for a period of slower growth means that it is likely that the Bank will cut the policy rate again early next year.

Like the BOC, RBC expects that the aggressive price cutting by Canadian retailers will keep downward pressure on Canada's core inflation rate allowing the Bank to pursue an easier policy stance as the economy navigates through this period of financial market turmoil. To be sure, the strong increase in domestic demand in the third quarter will keep the Bank wary about the risk that household spending will grow rapidly exerting upward pressure on prices related to housing.

However the downside risks emanating from the financial market uncertainty, commensurate tightening in credit conditions and weakening US growth outlook seals the case for an additional rate cut in early 2008.

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