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The Bank of Canada decision Wednesday to cut its key lending rate for the second time this year to 0.50 per cent signals a worry about the direction of the economy and a desire to soften any blows that may be coming.
The impetus behind the cut wasn’t really about getting you to borrow more or ease your borrowing burden. It was about widening the gap between our interest rates and those in the U.S. to push our dollar down.
“Canada’s economy is undergoing a significant and complex adjustment,” the bank said in its rate decision, noting there was a modest recession in the first half of the year as the economy contracted.
Our dollar started the day down a third of a cent to 78 cents, a level not seen in 10 years. That’s going to make snowbirds unhappy, but the central bank is more interested in fuelling exports to our larger trading partner.
Can the Bank of Canada really save the day? Rates are already so low, we’re at the point of diminishing returns. Each new cut is greater in percentage terms than the last, but the real impact is smaller and smaller.
1. Not much relief
If the rate is 0.75 per cent and falls to 0.50, it’s the same 33 per cent drop, but the saving is negligible. By the time it filters down through the banking system to your line of credit, the difference may add up to a Big Mac meal.
Wednesday’s move by the central bank means the banks will likely lower consumer borrowing costs a little. The betting is that they’ll give us 10 basis points and they’ll keep the other 15. TD Bank was first off the mark, doing just that.
So, suppose you’re a good bank customer. Your $ 100,000 secured line of credit is at prime, plus half a point, or 3.35 per cent (2.85 plus .50). You’re making an interest-only payment each month which comes to $ 279 a month.
The bank passes on 10 basis points. Your new combined rate is 3.25 per cent, or $ 271 a month. Spend that $ 8 wisely.
2. Indifferent businesses
“Another 25 basis points will do little to make or break a financing decision,” CIBC World Markets deputy chief economist Benjamin Tal said in a recent briefing note.With so many firms hoarding cash, the money they raise isn’t actually going into investments anyway. They’re either hanging on to it until conditions are clearer, or buying back company shares to boost the price of their stock.
3. Indifferent consumers
Tal argued that many consumers see the low rates as normal. He’s right, in that anybody 45 or younger has only lived in an environment of falling interest rates. So 10 basis points off is just more of the same and unlikely to generate much interest. A CIBC survey this week supports that notion. It finds little appetite for new borrowing with 93 per cent of its sample saying they are unlikely to take on more debt if rates dropped. A third said they’d accelerate debt repayment.
4. Drooping dollar
So what’s left?
Governments have two tools to stimulate the economy. One is monetary policy which raises and lowers rates. The other is fiscal policy which spends money to create demand. This creates jobs and by giving people more money to spend, increases demand: The virtuous circle.
“We have to stay the course. The largest and longest infrastructure (investments) in the history of Canada. Bringing (personal) taxes down. Corporate taxes are lower than the G7 average. But we can’t be profligate and we can’t do everything.”
It will be interesting to see how that strategy plays out in the economy and at the polls as we head into fall.
More columns by Adam Mayers