The Bank of Canada today announced another cut to the key lending rate. The Bank reduced the overnight rate by one-quarter of a percentage point to 0.25%.
Here is an interesting article by James Cowan of the National Post providing insight on the bank rates.
The Bank of Canada Tuesday cut its key interest rate to 0.25%. What does that mean?
The country's central bank, the Bank of Canada is responsible for improving the performance of the economy by managing the supply of money and availability of credit. The bank uses a small number of tools to accomplish this big goal. Perhaps most important tool is the target it sets for the "overnight rate," which is the interest rate that banks pay to borrow money from each other for single day. The target for the overnight bank rate is considered so influential, it is often called "the key interest rate" or "key policy rate."
Why should I care how much it costs a big bank to borrow money from another big bank?
By raising or lowering its target for the overnight rate, the bank is able to influence other interest short-term interest rates, which in turn influence interest rates on things such as mortgages and commercial loans. Following the Bank of Canada's decision to cut the key interest rate to 0.25% from 0.5%, the country's major banks all cut their prime lending rates by a quarter of a percentage point.
Could the key interest rate drop any lower?
It is unlikely. The current rate is the lowest in history and the Bank of Canada said yesterday that it believes 0.25% is the "effective lower bound" for the key interest rate. Indeed, the Bank has already been forced to make changes to accommodate the low, low rate. For example, it normally keeps overnight interest rates within .25% of its target, meaning banks pay a bit less or a bit more than suggested. However, the Bank said yesterday it does not want rates to wander any lower than its target, meaning banks could pay a more to borrow money, but not less than .25%.
Has the bank done anything else surprising with the key interest rate?
Yes. It announced that the key rate "can be expected to remain at its current level" for next year, effectively promising to keep interest rates low until April 2010. It is rare for central banks to project that far in the future, although the U.S. Federal Reserve recently made a similiar move, according to Aron Gampel, deputy chief economist for Scotiabank. "They used different words to instill the same message," he said. "For those who are concerned that the economy is never going to turn around, what the Bank of Canada is saying that it is really pedal to the metal."
So why would they promise to keep interest rates low?
Be careful -- it is not quite a promise. In a statement, the Bank did say the low interest rates will be "conditional on the outlook for inflation." Nonetheless, the Bank seems to be attempting to reassure both businesses and consumers that interest rates will stay low for the foreseeable future. "I think a lot of people are going to be taking advantage of that when they refinance their personal debt or they make decisions what to buy now, because they know the Bank of Canada has stated it will do its best to keep interest rates down," Mr. Gampel said.
This all seems rather extreme. Is the Bank out of options if this does not work?
No -- it can always try quantitative easing. Under this strategy, the Bank of Canada would produce additional money and use it to buy government bonds or other assets from banks. The goal is to give the banks more money, which they could then lend to their customers. "Money in the bank will not get us out of recession," said Peter Dungan, an adjunct professor of business economics at the University of Toronto. "It is the lending it out so people don't have to close their businesses or reopen them. If there's enough liquidity in the system, that is what gets us moving again."
Hang on, hang on. When you say "produce additional money," does that just mean printing more cash?
Kind of. The money is new but it is electronically added to the banks' accounts, meaning it is created by pressing computer keys rather a printing press.
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Sara Kareer
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Century 21 Millennium Inc., Brokerage
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