Still Plenty of Room for Interest-Rate Cuts

If any of you were worried about inflation in Canada, you can rest easy. The much-feared price level gauge slowed down by another 0.2% in January to about 2.2%. This effectively gave the country’s central bank carte blanche to keep on cutting interest rates in order to jump-start the slowing economy.

In terms of the year-over-year numbers, according to Statistics Canada, the consumer price index was at its lowest point since last August. Why? Lower taxes and the rising loonie have kept inflation “on ice” for the past few months.

More specifically, core inflation, which does not account for the impact of food and energy prices (traditionally the most volatile items in the consumers’ basket of goods and services), decreased for the seventh month in a row to 1.4%, down from 1.5% reported in December.

The fact that inflation is low and more interest-rate cuts are expected, such a constellation of economic developments usually leads to a depreciating currency. When interest rates are low, a domestic currency typically becomes less attractive to foreign investors.

The next question on everyone’s lips would be by just how much could interest rates go down? As already stated, at the moment, inflation is not of immediate concern to the Bank of Canada. Therefore, private sector banking believes we are going to hear something drastic out of the central bank’s new governor, Mark Carney in March, when Canada’s equivalent of the Federal Reserve meeting is scheduled.

Economists appear to be split on the size of the cut: one group is calling for a dramatic interest-rate cut of 50 basis points, or a half a percent, while there are others who believe that Carney will stick to his predecessor’s, David Dodge’s, incremental strategy of reducing/increasing interest rates by 25 basis points, or a quarter of a percent. In any event, interest rates will keep on declining in Canada.

Bear in mind that although statistically the consumers’ price index has been declining for a while now, there are still reasons to fear inflation, such as the strong labor market and reasonably strong wages that Canadians are earning. Meaning, there are still pockets of potential price increases that may reverse the effects of seven months of decline.

As for the longer-term outlook for interest rates in Canada, economists expect a slide from four percent to three percent by the end of the second quarter. Obviously, Canada is not immune to the effects of global economic slowdown. We are already seeing weak exports and manufacturing, mostly due to the economic slowdown of our largest trade partner — the U.S. Further worsening matters were recently published wholesale numbers that declined 2.9% in December, which is much weaker than the increase of 0.2% that forecasters were calling for.