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Canada ‘entering a recession,’ central bank slashes key rate to 1.5 per cent

NEWS HIGHLIGHT

Canada 'entering a recession,' central bank slashes key rate to 1.5 per cent
The Bank of Canada took an axe to short-term interest rates Tuesday,
warning of a deteriorating global economy and declaring for the first
time that Canada has stumbled into a recession.

The Bank of Canada took an axe to short-term interest rates
Tuesday, warning of a deteriorating global economy and declaring for
the first time that Canada has stumbled into a recession.

The
lower interest rates, if passed on by the commercial banks, will make
it less costly for businesses and households to borrow for expansion
and consumption. Such spending boosts economic growth and provides jobs
to stimulate the recessionary economy.

But it appears the
commercial banks will not pass on the full three-quarters of a point
cut by the Bank of Canada, which lowered its overnight rate to the
lowest level in half a century at 1.5 per cent.

For many years,
Canadian banks maintained a consistent spread between their prime rate
and the Bank of Canada's overnight rate but recently they have
sometimes allowed the gap to widen.

But TD Bank (TSX:TD) – the
first to react to the central bank's move – said Tuesday it would trim
its prime lending rate by half a point to 3.5 per cent.

Most of
the other major banks followed suit with a half-point cut to their
prime rates, which sets the bar for many business and consumer loans,
including open mortgages.

In early October, the chartered banks
also balked at passing through fully the Bank of Canada's rate
reduction but later made up the difference when Ottawa agreed to buy
$25 billion in mortgage assets off their books.

The central
bank's dramatic chop to the overnight rate Tuesday was the largest
since October 2001 in the aftermath of the 9-11 terrorist attacks.

The
bank said dramatic action was needed given the rapidly deteriorating
global economy and the impact of the financial crisis and plummeting
commodity prices.

"The outlook for the world economy has
deteriorated significantly and the global recession will be broader and
deeper than previously anticipated," it said in a statement
accompanying the decision.

"While Canada's economy evolved
largely as expected during the summer and early autumn, it is now
entering a recession," it added.

"The recent declines in terms of
trade, real income growth, and confidence are prompting more cautious
behaviour by households and businesses."

A recession is commonly
defined as two consecutive quarters of economic shrinkage and by that
measure Canada has avoided a recession this year since there was growth
in the third quarter.

However, given a sudden drop in economic
activity that began in October and prospects of continued slowdown
throughout early 2009, many economists have said Canada's recession has
begun in earnest.

Although most private-sector analysts had
predicted a half-point cut from the central bank, Scotia Capital
economist Derek Holt praised it for rising to the needs of the economy.

Given
the "dovish" tone of the bank statement, Holt said Canadians should
expect another half-point cut at the next scheduled rate decision date
on Jan. 20. He said it is possible the overnight rate – the rate banks
charge each other on one-day loans – will fall below one per cent by
late winter.

"Beforehand, they were criticized for not being aggressive enough but now they have come around," Holt said.

Tuesday's
statement was the first in which the Bank of Canada was unequivocal
that the country had fallen into a recession. The closest that governor
Mark Carney had come previously was last month when he said recession
was a distinct possibility.

Since then the vast majority of
economic indicators have been in retreat, including retail sales, auto
purchases, housing starts and prices, commodity prices – and
dramatically – last month's 70,600 shrinkage in jobs.

The central
bank's move was partly a "catch-up" after it did not cut rates more
deeply in October, and was urgently needed because of the lack of
economy-boosting spending by the Conservative federal government,
commented IHS Global Insight economist Dale Orr.

"Today the cry for fiscal stimulus for Canada is loud and clear," Orr wrote.

"Instead
of examining what the government could do to stimulate the economy
facing such difficult times, the government opted to try to present a
balanced budget."

Although monetary and fiscal stimulus differ in
the manner they boost growth, Orr said interest rates cuts are
preferred by economists because their impact is quicker and can more
readily be reversed when the economy recoups.

Prime Minister
Stephen Harper and Finance Minister Jim Flaherty have said they will
present a stimulus package in the budget scheduled for Jan. 27 –
although the opposition parties have called for more speedy action and
had threatened to topple the minority government over perceived
inaction.

Given the lag time needed to get major infrastructure
projects started, Holt said it was essential for the Bank of Canada to
show leadership because Ottawa's stimulus -when it comes – may not
impact the economy for another year.

Lower interest rates, if
passed on by the commercial banks, encourage businesses and households
to borrow for expansion and consumption.

The central bank will not publish new projections for the economy until Jan. 22, just days before the next federal budget.

In
its new outlook, IHS Global Insight projects the Canadian economy will
shrink 0.4 per cent in 2009 and full recovery would not occur until
late 2010.

The Bank of Canada did not predict how long the slump
will last but said bold actions by governments and central banks,
especially in the United States and Europe, are beginning to loosen up
money markets and support world economic growth.

It said other
factors are helping Canada counter the economic slowdown, including the
depreciating loonie which is making exports more competitive.

After
the rate reduction, the currency fell by more than a cent to below 78
cents US. but gained back some of the loss in later trading.

-The Canadian Press