Forex Investment and Currency Trading

The Bank of Canada delivered one last 25bps rate cut today to leave the overnight rate at an effective floor of 0.25%.
 
Using a surprising degree of transparency, the Bank stated that it will leave the overnight rate there until June 2010 to flatten the yield curve.
 
The Bank also downgraded its economic forecasts for both 2009 and 2010.
 
The comments on policy alternatives did not include much detail, but they opened the door to quantitative easing and market expects more on that front when the Bank releases the Monetary Policy Report on Thursday.

The Bank of Canada cut the overnight rate by 25bps to 0.25%. The Bank noted that this is the floor for the overnight rate, suggesting that rates will go no lower. What did come as a surprise though was the astonishing transparency by the Bank as it explicitly stated that rates will remain at this level until June 2010. This level of transparency is unprecedented but it speaks to the dire state of the economy and a desire to control expectations.

In the communiqué, the Bank admitted that given the synchronized nature of the recessionary headwinds, the global economic downturn has intensified. As such, the recession in Canada has also “been deeper than anticipated.” The Bank further downgraded not only its economic forecast, but also its estimate of potential growth. GDP in 2009 now expected to contract by 3.0%, which is lower than the 1.2% drop anticipated in January. The recovery is not expected to occur until the fourth quarter.  In 2010, the Bank now expects GDP to advance 2.5%, compared to 3.8% reported in the January MPR Update. In terms of inflation, the Bank expects core inflation pressures to subside through 2009. Core inflation should only return to the Bank’s 2% target by the third quarter of 2011. Headline CPI is expected to bottom out at -0.8% in Q3 2009 and should return to the 2% target by the third quarter of 2011. And even with these downgraded forecasts, the Bank still highlighted downside risks to these numbers, suggesting that there is indeed a lot of uncertainty.

Aside from the downgraded forecasts, the other focal point for the statement was contained in the Bank’s verbiage on possible alternatives to monetary policy. They did not provide much in that regard. The Bank did note however, that “with monetary policy now operating at the effective lower bound for the overnight policy rate, it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities.” We can expect more detail on Thursday when the MPR is released.

The Bank may eventually employ quantitative easing, but it needs to set out a framework first, which will occur on Thursday. Once that is done, the Bank can use these alternative policy tools at their discretion. Nothing is likely to happen immediately as the Bank “retains considerable flexibility in the conduct of monetary policy at low interest rates, consistent with the framework to be outlined in the Bank’s Monetary Policy Report on 23 April.”