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TIME FOR ANOTHER CUT?

The Bank of Canada releases its first policy decision of 2016 on Wednesday – and expectations are mounting the central bank cuts its key interest rate for the third time in a year

Just a few weeks ago, a January interest-rate cut seemed unlikely. But as storm clouds gather over the Canadian economy – highlighted by further erosion in oil prices – a growing chorus is predicting the Bank of Canada trims its key rate, now at 0.5 per cent, by 25 basis points to 0.25 per cent.

Still, Wednesday's outcome is far from certain. Here are three reasons why the central bank may cut rates, along with four reasons it may hold steady.

Reasons to cut

Oil prices

Oil prices have crumbled since the Bank of Canada's last economic forecast was released in October. Brent crude and West Texas Intermediate, two key benchmarks, have plunged more than 20 per cent in the new year and currently trade below $30 (U.S.) a barrel. Other commodity prices are tanking, as well. For Canada's resource-rich provinces – most notably Alberta and Saskatchewan – more pain is likely in store after a brutal 2015.

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The economy

The Bank of Canada's last Monetary Policy Report said economic growth would accelerate to 2 per cent in 2016 – a rate now seen as overly optimistic, given recent developments. As such, Governor Stephen Poloz and company are expected on Wednesday to downgrade this year's growth forecast. The most recent readings are hardly encouraging, either. Gross domestic product was unchanged in October, following a contraction the previous month. David Madani, who covers Canada for research firm Capital Economics, recently wrote the commodity rout "has completely undermined prospects for economic growth" in 2016.

Given the extended slump in the oil patch and its subsequent impact on the economy, the Bank of Canada may deem it necessary to cut its benchmark rate for the third time since the collapse in crude prices began.

Corporate plans

The Bank of Canada's latest survey of business executives, released last week, offered a grim outlook from corporate Canada. Responses signalled that "business sentiment has deteriorated," the central bank said, as the ill effects of the commodity rout spread. Moreover, the survey showed hiring and investment intentions have fallen to their lowest levels since 2009. Easing borrowing conditions may encourage more Canadian businesses to open their wallets.

Reasons to hold

The dollar

A rate cut would risk driving the Canadian dollar even lower. The loonie, one of the worst-performing major currencies of 2015, has dropped 5 per cent this year to 68.68 cents (U.S.) as of Monday's close. There are certainly benefits and drawbacks to a low loonie, but at what point does the bad outweigh the good?

"By almost any measure, the currency has dropped to levels at which many sectors can compete, and the benefits to industry will take time," said Bank of Montreal economists Douglas Porter and Benjamin Reitzes in a research report. "On the other side, the sliding currency threatens to deliver a hammer blow to already-sagging consumer confidence, swamping any stimulative benefit from lower borrowing costs."

Household borrowing

Canadians have gone on a borrowing binge in recent years, driving household debt to record levels. The ratio of household credit-market debt to disposable income climbed to a fresh record of 163.7 per cent in the third quarter of 2015, according to the latest data from Statistics Canada. The bulk of borrowing is for mortgages.

A rate cut would only make borrowing conditions even easier at a time when the nation's growth outlook is weak, Canadians are more indebted than ever, and two major housing markets – Vancouver and Toronto – are looking particularly frothy. Furthermore, Ottawa recently took steps to tighten mortgage financing rules.

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"Another rate cut could fan a market with one hand that policy makers are trying to slowly tamp down with the other," said BMO's Mr. Porter and Mr. Reitzes.

A cut isn't a cure-all

Trimming rates won't cure what ails the Canadian economy. A rate cut won't put Canada on a significantly higher growth track, nor can the central bank affect commodity prices, Toronto-Dominion Bank chief economist Beata Caranci said in a research report. "As such, [the bank] can do little to alleviate the economic pain occurring within the oil and gas industry: its workers, investors and, by extension, related suppliers."

Ottawa's stimulus plan

Mr. Poloz may choose to wait on the sidelines before the federal Liberal Party reveals details of its infrastructure spending plan, a key plank of its election platform.

Further reading:

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