Balance of risk shifts, bank cuts rates

The Bank of Canada lowered borrowing costs yesterday for the first time in more than 31/2 years, citing the negative impact of the dollar's recent dramatic rise, turmoil in financial markets that has resulted in tighter credit, and a slowdown in the U.S. economy that could hamper growth in Canada.

The central bank, which lowered its key lending rate by a quarter-point to 4.25 per cent, also said the risk of inflation had decreased marginally since October.

"All these factors considered, the bank judges that there has been a shift to the downside in the balance of risks around its October projection for inflation through 2009," it said

The bank added that the economy "continues to operate above its production capacity."

"The Canadian economy has been growing broadly in line with the bank's expectations, reflecting in large part underlying strength in domestic demand," it said. "There is an increased risk to the prospects for demand for Canadian exports as the outlook for the U.S. economy, and in particular the U.S. housing sector, has weakened."

The economy expanded more than expected in the third quarter, growing 2.9 per cent, but still below a 3.8-per-cent advance in the second quarter. Meanwhile, core inflation was running below the bank's two-per-cent target in October -- partly due to price cuts by retailers to accommodate the high-flying loonie -- and unemployment was at a 33-year low of 5.8 per cent in October. Some economists, however, expect the jobless rate to rise to 5.9 per cent in the November report, which will be released on Friday along with U.S. employment numbers.

"What [the bank] is really saying is that it can afford to cut rates and not have inflation," said TD Financial Group deputy chief economist Craig Alexander.

The decision, however, sent the dollar tumbling. The loonie began falling after the bank's morning announcement and ended trading yesterday at 98.78 cents US, down from Monday's close of 99.98 cents. The dollar -- which rose above parity with the U.S. currency on Sept. 20 for the first time in three decades and hit a modern-day high of $1.1039 on Nov. 7 -- has been falling sharply ever since on worries that the currency had risen too far, too soon.

Yesterday's rate cut by the Bank of Canada -- which was followed quickly by prime-rate cuts by commercial banks, effective today -- marked the first time the bank has lowered borrowing costs since April 2004.

(prepared by Gordon Isfeld/Vancouver Province)