With interest rates at historic lows, could it possibly make sense to go even further?
It came as a shock to just about everyone when Bank of Canada governor Stephen Poloz announced the central bank would lower its benchmark lending rate in January to 0.75 per cent.
That’s because after more than four years with a historically low one per cent, Canadians had been hammered with repeated warnings to pay down debt because lending rates were bound to go up — at some point.
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Then a cratering oil price changed the narrative. When the bank cut rates in January, it was six months into an oil drop that saw crude go from $95 a barrel this time last year to under $50. That was devastating for the oil patch — but also for the rest of Canada’s economy.
“This decision is in response to the recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada,” the bank said in explaining its bombshell rate cut.
Eagle eye on inflation
Although the bank keeps an eye on all sorts of economic data, the most important one from a monetary policy perspective is inflation — the upward creep of prices over time. The bank has a mandate of inflation targeting because according to many economists, if you can keep inflation in a narrow band between one and three per cent, everything else in the economy — from jobs, to GDP and the like — tends to take care of itself.
Lower lending rates make borrowing easier, which stimulates spending and investing, which nudges up inflation. Raising rates does the opposite. At least, so goes the theory.
When the bank cut rates in January, it raised the possibility of another one down the line. With Canada’s inflation rate currently at 0.9 per cent, there would seem to be ample wiggle room to cut again.
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