BMO expects Bank of Canada to cut key interest rate to record low

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The Bank of Canada will have to slash its key interest rate by another three-quarters of a percentage point in its next rate decision in mid-April, Bank of Montreal says, as plunging oil prices and mounting coronavirus fears prompt economists to rewrite their economic and rate forecasts.

“Given the expectations for weaker growth, we anticipate that the Bank of Canada will be cutting rates 100 basis points over the next two meetings,” BMO’s economics department said in a research note Tuesday. (A basis point is one-hundredth of a percentage point.)

It said it anticipates a 75-basis-point cut in the bank’s next rate decision on April 15, and another 25 basis points in the following decision on June 3.

If that happens, it would reduce the BoC’s key rate to 0.25 per cent – matching its record low, set during the financial crisis in 2009. Other private-sector forecasters haven’t yet matched BMO’s 75-basis-point call, but the economics departments at the country’s other big banks are looking to revise their own forecasts this week – and they also hinted that deeper rate cuts are on the way.

“I don’t think any of us can put a pin [on] what the timing is going to look like ... but we’re pretty comfortable with 100 basis points over all by the summertime,” BMO chief economist Douglas Porter said in an interview. “The central banks will be pretty aggressive to get out ahead of this.”

Interest-rate derivatives in the bond market imply that traders see a 50-point cut in April as most likely. But they have priced in further cuts extending to the summer, likely bottoming at either 0.5 per cent or 0.25 per cent.

Central banks typically adjust rates in quarter-point increments, but the escalating COVID-19 outbreak has increased the urgency for policy makers in Canada and around the world to provide support to an increasingly unstable global economy and financial markets. A week ago, the BoC cut its rate by half a percentage point, to 1.25 per cent, matching the half-point cut that the U.S. Federal Reserve had announced 24 hours earlier.

The situation has deteriorated since then, raising the alarm further. “What changed for us was the oil price shock,” Mr. Porter said.

The plunge of U.S. benchmark West Texas Intermediate crude to barely above US$30 a barrel presents a considerable blow to Canadian growth forecasts, which generally assumed oil would average more like US$50 to US$60 for the year.

Basing its new forecasts on a US$40-a-barrel average, BMO now anticipates the economy will contract by a sharp 3.5 per cent annualized in the second quarter – expected to be the peak quarter for COVID-19′s impact – compared with its previous forecast, from last week, of a 0.6-per-cent decline. It predicts that growth for all of 2020 will be 0.5 per cent.

The BoC’s most recent quarterly outlook, issued in January, projected full-year growth at 1.6 per cent, matching 2019′s pace. The central bank will issue new forecasts in conjunction with its April rate decision.

The U.S. Federal Reserve could set the bar for the BoC next week, when it meets again to decide on rate cuts. The pricing of interest-rate derivatives in the bond market indicate that traders are now betting the Fed will cut by 75 basis points, although many economists still think a repeat of last week’s 50-point cut is more likely.

Beata Caranci, chief economist at Toronto-Dominion Bank, says she believes the BoC will want to keep pace with the Fed for the time being, as it won’t want to draw currency investors to the Canadian dollar by offering more attractive rates than its U.S. counterpart. A weaker loonie in times of depressed commodity prices is considered a valuable stabilizer for the Canadian economy, as it makes non-resource exports more price-competitive in foreign markets.

“If the Fed goes 50 [basis points] next week, we’ll probably follow,” she said.

Another key determinant for the BoC will be what the federal government announces in the way of spending – fiscal stimulus – to support the economy, which would take some of the pressure off interest rates to do all the work. Prime Minister Justin Trudeau said Tuesday the government will announce measures “very soon” to address some of the economic fallout from the COVID-19 outbreak.

Ms. Caranci said she and her colleagues at TD are holding off predicting further rate cuts beyond April, until she sees what Ottawa delivers.

“We’re expecting a significant amount of fiscal assistance,” she said. “We’re not putting it all on the Bank of Canada.”

BoC Governor Stephen Poloz has previously estimated that $5-billion in fiscal stimulus has roughly the same economic impact as a quarter-point rate cut. But so far, Ottawa has given little indication of what it has in mind in terms of fiscal support.

“It’s not at all clear what order of magnitude they’re talking about,” Mr. Porter said.

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