Bank of Canada Cuts Interest Rate Amid Coronavirus Uncertainties

The Bank of Canada (BOC) cut its key interest rate on Wednesday for the first time since July 2015 amid escalating fears over global economic implications of the coronavirus outbreak.

The BOC cut its benchmark lending rate by half a percentage point, to 1.25 per cent from 1.75 per cent, matching the emergency cut announced by the U.S. Federal Reserve a day earlier.

"While Canada's economy has been operating close to potential with inflation on target, the COVID-19 virus is a material negative shock to the Canadian and global outlooks, and monetary and fiscal authorities are responding," the BOC said in a news release.

Market watchers had anticipated in recent days that Canada's central bank would cut rates as a result of ongoing market volatility over COVID-19 uncertainties.

"The plunge in global equity markets and sharp drop in commodity prices, in particular oil, are bumping up the risks that the confidence hit in financial markets will be mirrored in household and business sentiment," Dawn Desjardins, Deputy Chief Economist at RBC, said in a recent note.

The BOC, which called COVID-19 a "significant health threat," said the first quarter of 2020 is now expected to be weaker than it originally projected. "The drop in Canada's terms of trade, if sustained, will weigh on income growth. Meanwhile, business investment does not appear to be recovering as was expected following positive trade policy developments. In addition, rail line blockades, strikes by Ontario teachers, and winter storms in some regions are dampening economic activity in the first quarter," it announced Wednesday.

Canada's central bank also stated it "stands ready to adjust monetary policy further if required to support economic growth and keep inflation on target."

The BOC sets eight fixed dates each year to announce if it will make a change to interest rates. The next rate decision is set for April 15. In the U.S., the Federal Open Market Committee (FOMC) executes monetary policy for the Federal Reserve and holds eight scheduled meetings each year. Tuesday's unscheduled FOMC meeting marked the first time the Fed has taken action between meetings since October 2008, according to RBC Economics.

Why do central banks turn to interest-rate cuts during times of economic instability? The BOC's key interest rate influences other interest rates, including rates for consumer loans and mortgages. In short, low interest rates can help stimulate an economy by providing an attractive borrowing environment for businesses that may wish to expand or consumers who may be considering big-ticket purchases. Find out more in What Low and Negative Interest Rates Mean for Investors.

Still, in the case of coronavirus, "it is an open question whether lower interest rates would actually help very much if economies are forced to temporarily close," RBC GAM Chief Economist Eric Lascelles said in this week's MacroMemo Economic Update. "No amount of monetary stimulus will bring workers back into the office if the government tells them to stay away, though the subsequent journey back to normal output would be somewhat smoother."

The BOC said it continues to closely monitor economic and financial conditions alongside other global central banks and fiscal authorities.

Just this week, the Organisation for Economic Cooperation and Development (OECD) lowered its economic growth forecasts due to the viral outbreak, now predicting annual global growth of 2.4 per cent in 2020, down from its previous 2.9 per cent prediction. However, should the outbreak last longer and spread more significantly, the OECD warned global growth could drop to just 1.5 per cent this year.

For a roundup of coronavirus coverage, plus timely reminders and tools that can help when markets are volatile, click here.