Canada Cuts Rates As Economy Looks Up

"There is no question that the economy did much better in the third quarter than it did in the first half of the year," said Ted Carmichael, senior Canadian analyst with JP Morgan Securities Canada in Toronto.

"But by its action today the Bank seems to be trying to buy additional insurance, to ensure that the economy will continue to grow at a strong rate through year end and into 1997," Carmichael said. The central bank dropped its key bank rate by 25 basis points to 4.0 percent, a move that prompted Canada's major banks to cut their prime lending rates to 5.5 percent from 5.75, the lowest level since February 1994.

 

With the Bank cutting interest rates by two percentage points this year and 4.25 percentage points since May 1995, economists are speculating that short-term interest rates may have reached bottom for the near term.

The latest cut came on the heels of a series of economic data suggesting that growth was picking up in the second half of the year. I

t was seen by analysts as more of an effort to temper a rally in the Canadian dollar than to give the economy a further shot in the arm.

"The message from the Bank of Canada is loud and clear: A strengthening economy is no impediment to lower rates as long as the Canadian dollar is firming," Nesbitt Burns chief economist Sherry Cooper said in a comment. "While growth is piking up, there is still some slack in the economy."

Despite the Bank's aggressive easing, Canada's economy remained sluggish in the first half of 1996.

But recent data showing faster growth suggested the rate cuts were starting to pay off.

Earlier this week, Statistics Canada said gross domestic product grew by 0.5 percent in July. The GDP rise was led by a 1.8 percent increase in manufacturing production, the largest increase since December 1994.

Growing retail trade and gains in wholesale trade and construction added to the rebound.

Moreover, Canada's stubbornly high unemployment rate has begun to fall. Unemployment shrank to 9.4 percent in August as the economy created 75,000 full-time jobs.

The unemployment rate retreated to its May level after soaring to 10.0 per cent in June.

"Domestically and economically, we think the fundamentals are vastly improved, compared to when the Bank really started easing earlier this year," said Steve Saldanha, economic analyst with Canada Trust.

Michael Manford, chief economist at ScotiaMcLeod, said Wednesday's rate cut would probably be the last in the series, especially if economic data continued to point to a recovery.

"I think that toward the year end, the Bank will be definitely neutral," Manford said. Other analysts said that if the Canadian dollar kept strengthening, the Bank might be forced to lower rates again to maintain easier monetary conditions.

A rising currency usually brings about tighter monetary conditions, which can be offset by lower short-term interest rates.

"They have a bias to ease until we get convincing evidence on the ground that reasonable economic growth has a lot of forward momentum," said Michael Gregory, economist with Lehman Brothers in Toronto.

"Clearly the evidence we've seen is a month or two of decent data following about a year and a half of sluggish data. You can't rule out another rate cut."