The market believes there is a 50% chance the Bank of Canada will decrease the overnight rate this week. This will send our weak Canadian Dollar even lower, and might not be in Canadians’ best interest.
The Bank of Canada and the Federal Government are extremely concerned about the rapidly dropping price of oil. We are now firmly below $30 a barrel and this means that much of the oil Canada has is not economically viable. With prices dropping so low, Western Canadian oil producers are shuttering facilities quicker than the Bank of Canada anticipated. This means slower economic growth is in store for Canada’s future. When a Central bank sees growth slowing a typical response is to decrease rates to help the economy.
It is our belief that the only way a decrease in the overnight rate will help Canadians is if the major Canadian banks decide to pass on the entire rate discount to Canadian borrowers. Unfortunately, this can no longer be taken for granted. We have already seen Canadian banks mute the stimulus effect they decide to pass on to borrowers by only reducing the Prime rate by a portion of what the Bank of Canada decreases the overnight rate by. The past two attempts made by the Bank of Canada to reduce borrowing rates have resulted in Canadians only seeing a portion of the rate savings. In January of 2015 the Bank of Canada dropped the overnight rate by 0.25% and this resulted in only a 0.15% drop in the Prime rate that Canadian borrowers can see. Then again in July 2015, the Bank of Canada reduced borrowing rates by 0.25%, of which the Canadian banks decided to pass along only a 0.15% rate drop to the Canadian borrower.
Canada finds itself in a precarious economic position at present. Decreasing interest rates has positive and negative effects.
Lower rates can stimulate economic growth by lowering borrowing rates (although how much more borrowing should we really be doing?). They will also decrease the value of our currency which typically helps an economy by making it more competitive (cheaper for other countries to buy our goods and services).
Although the lower Canadian dollar should make us more competitive in exporting goods and services to the United States, this hasn’t really happened. The problem appears to be that both consumer and business confidence is suffering from a free falling currency and manufacturing and exports are not picking up the slack. Perhaps the fact that 73% of new machinery and equipment is imported has something to do with this. When companies see uncertain times they rarely make big purchases, especially when the value of their dollar has been decimated. In fact, the Canadian Manufacturing and Exporters Chief Executive believes the Bank of Canada might want to look at increasing rates to add some stability in the market.
Decreasing interest rates now will no doubt further erode both consumer confidence and disposable income as the cost of the items we purchase from the United States continues to increase. Less money in Canadian pockets is not a good thing at a time when our economy is trying to rebalance.
Many people have opinions as to whether or not the Bank of Canada should cut rates this week. I am not convinced that this cut is a good idea. I am however convinced that if the Bank of Canada does cut rates the entirety of the rate cut should be passed on to the Canadian consumer. If Canadians are forced to deal with a weaker dollar and more expensive discretionary items – groceries, clothes, electronics, and so on – they are at least entitled to the full benefit of the rate drop.
Perhaps the Bank of Canada should hold off to see how much of our money the Federal Government intends to spend on infrastructure before we depress the Canadian Dollar any further.