Bank of Canada Shocks With Rate Cut "Insurance" Against Oil Slumps

By Nirmala Menon 

        OTTAWA--Canada's central bank delivered a shock interest-rate cut Wednesday, becoming the first Group of Seven country to slash rates in response to the oil-price collapse and its impact on economic growth.
        The Bank of Canada, which had been widely expected to hold rates steady before raising them later in the year or in early 2016, cut its benchmark overnight rate by a quarter percentage point to 0.75%--the first cut to the rate since April 2009, when the economy was mired in recession.
        Sliding oil prices, which the central bank said it expects will recover to around $60 in the medium-term, will erode growth and inflation for Canada, it said in a statement announcing the interest-rate cut. It lowered its growth forecast for the first half of 2015 to 1.5% and to 2.1% for the full year from 2.4%.
        The bank offered no signals ahead of time that it might change course on rates, and the news was greeted with shock in Canada, where some exporters cheered the accompanying fall in the currency and in the cost of debt.
        But that potential fall in debt costs will likely stoke fears that the Canadian consumer, already the most overleveraged among major economies, could borrow more, a risk the bank highlighted on Wednesday.
        Canada's central bank made the move as the European Central Bank is readying a proposal for a quantitative easing program of EUR50 billion (U.S. $58 billion) a month aimed at stimulating growth.
        Slower global growth and demand for energy, especially in emerging markets like China, is weighing heavily on crude prices because production is surging, especially in North America.
        While other economies, including that of the U.S., will get a boost from lower energy prices that may stimulate consumers to spend more, the slump will be "unambiguously negative" for Canada, the Bank of Canada said. Unlike the U.S., Canada is a net exporter of oil. Energy extraction and related industries account for a much bigger share of the economy, with around 11% of GDP stemming from direct and indirect energy activities, according to government data.
        The Canadian central bank's decision to cut rates is a marked policy divergence from the U.S. Federal Reserve, which is widely expected to start raising rates this year. Other central banks that have recently cut rates include those of Denmark, Egypt, India, Romania and Turkey.
        Stephen Poloz, the governor of the Bank of Canada, acknowledged at an Ottawa news conference that the move had surprised markets. "The market consequences will be what they are," he said.
        Last week, Bank of Canada Deputy Governor Timothy Lane, after a speech titled "Oil Prices and their Impact on the Economy," told a trade group in Madison, Wis., that there wouldn't be any "drastic" changes in the Bank of Canada's policy outlook.
        The Canadian dollar fell sharply Wednesday, dropping 1.8% from Tuesday's close, moving to 81.29 U.S. cents in late trading from 82.55 U.S. cents late Tuesday, according to data provider CQG.
        Canada's main stock benchmark gained on the rate cut, but a global bump in oil prices accounted for the biggest part of the index gain, with the S&P/TSX closing up 1.8% and the heavily weighted energy group rising 3.2%, following higher crude prices in New York trading. Interest-rate sensitive financials and industrial groups, which may benefit from a boost in domestic and export economic activity resulting from rate cut, also gained.
        The Canadian dollar dropped sharply Wednesday, losing about 1.5% by midday trading since late Tuesday. The U.S. dollar was most recently at C$1.2305, up from C$1.2114 at Tuesday's close, according to data provider CQG.
        Canada's main stock benchmark gained on the rate cut, but a global bump in oil prices accounted for the biggest part of the index gain, with the S&P/TSX rising by 1.9% in midday trading and the heavily weighted energy group rising 4.5%, following higher crude prices in New York trading. Interest-rate sensitive financial and industrial groups--which may benefit from a boost in domestic and export economic activity resulting from rate cut--also gained.
        Many here welcomed the drop in the Canadian dollar. For Canada's large mining industry, the loonie's fall helps to offset lower commodities prices, given those prices are denominated in U.S. dollars.
        "Absolutely, that is good news for us," said George Ogilvie, the CEO of Ontario-based miner Kirkland Lake Gold Inc. At current levels, the fall in the loonie against the dollar will add some $31 million this year to Kirkland's balance sheet.
        But while rate cuts are typically good news for indebted companies, the heavily leveraged Kirkland Lake isn't taking too much comfort from Wednesday's news. "What we've seen in the past is sometimes the bank makes a rate cut but the private and commercial lenders don't pass them on to general public" and companies, Mr. Ogilvie said.
        In the manufacturing hubs of Quebec and Ontario, a weaker dollar has been viewed as a support for exports, which have recently started to regain some of the ground lost during the recession and its aftermath.
        But a weaker currency amounts to a double-edged sword for some companies, since so much of their input costs are in U.S. dollars. "When our dollar falls, the cost of our inputs increases," said Trevor Welch, president and general manager of Textile Manufacturing Co. Ltd., a Toronto-based producer of braided goods such as skate laces and cords for clothing such as hoodies.
        "The upside is that when it comes time to sell our goods internationally, we are more competitive--at least in the U.S. market," Mr. Welch said. That market accounts for 10% to 25% of the company's sales, depending on the year, he estimates.
        Textile Manufacturing, which will mark its 100th anniversary next month, is actively looking for new U.S. customers. "We're in the game again," said Mr. Welch, in reference to the weaker Canadian dollar.
        Still, there is "considerable uncertainty about the speed" of recovery in non-energy exports, the central bank said in its statement. And those gains are unlikely to outweigh the drag of lower oil prices, especially on business investment, which has been led by the resource-rich countries.
        Reaction in Calgary, the hub of the country's energy industry, was muted since the rate cut isn't expected to reverse the direction of global oil prices.
        "The feeling in the corporate community overall is that it's not going to do a heck of a lot. The key challenge is a lower global oil price. The interest rate cut won't alleviate the pain created by lower oil prices," Adam Legge, president of the Calgary Chamber of Commerce, said in an interview.
        In a review of its industry forecasts, the Canadian Association of Petroleum Producers, an industry group, estimates a 33% decline in capital spending in 2015 and a projected slowdown in growth of oil production from its prior forecast of about 65,000 barrels a day in 2015 and 120,000 barrels a day in 2016.
        According to the review, capital investment in Western Canada, including the oil sands, will total $46 billion in 2015, down 33% from $69 billion invested in 2014. The new 2015 forecast for total Western Canadian oil production is 3.6 million barrels a day, about 150,000 barrels a day higher than total 2014 production of 3.5 million barrels a day, with a similar rate of growth expected in 2016.
        Alistair MacDonald, Rita Trichur and Chester Dawson
        Write to Nirmala Menon at nirmala.menon@wsj.com
        (END) Dow Jones Newswires

        January 21, 2015 17:21 ET (22:21 GMT)

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