INTEREST RATES: bank slashes to 1958 level

(The Bank of Canada has joined the global campaign to prevent a broad recession from spiralling into an economic disaster, cutting interest rates to a 50-year low and dropping its focus on inflation.

After a series of smaller rate cuts this year that reflected the Bank of Canada's belief that the country was escaping the worst of the global slump and financial crisis, the central bank officially pronounced Canada to be at the beginning of a recession yesterday. It aggressively slashed its benchmark rate by three quarters of a percentage point to 1.5 per cent, a level not seen in Canada since 1958 and the steepest cut since the aftermath of the Sept. 11, 2001, terrorist attacks.

That puts the bank's key rate three full percentage points lower than where it was a year ago, and actually below the core rate of inflation - meaning that it acts as a total disincentive to save.

While Canada's rates are not as low as in the United States, they are heading in the same direction. Canada joins many European countries, as well as Britain, Australia and New Zealand, in making super-sized cuts to rates to fend off the deepest recession in decades. And with more cuts likely to come, according to economists, Canada is on a path toward the lowest interest rates in its history, as the central bank attempts to nurse the country's economy back to health.

But that could be a long road. Plunging commodity prices, sagging global demand and a reluctance by consumers to spend have choked off the income flowing to Canadian businesses, governments and homes, the bank said. It did not say when it sees an end to the Canadian recession, or how it sees a recovery taking place. That's unusual because the bank almost always gives a timeline for when it sees the economy getting back on track.

The country's big banks said they are prepared to mirror just part of the central bank cut for now, lowering their prime rates by half a percentage point. With commercial banks reluctant to pass on the full extent of the central bank reductions to their customers, and fiscal policy on hold until Parliament returns in January, the Bank of Canada is the only stimulus machine operating at full tilt these days.

"The situation requires this kind of response," said Darcy Briggs, portfolio manager at Calgary-based Bissett Investment Management.

With household and corporate incomes under pressure, the credit market not functioning properly, and the timing of fiscal stimulus uncertain, bold moves from the central bank were required, Mr. Briggs said.

In making the aggressive cut, the bank moved away from its focus on inflation. Over the last year, the bank frequently mentioned the risk of inflation as a reason for not cutting rates more steeply.

No longer. Inflation will likely drift lower, the bank signalled. Now, households and businesses are holding back, as their confidence and their incomes are undermined by falling commodity prices and the global recession, the bank said.

One important offset, according to the central bank: the depreciation of the Canadian dollar.

The currency, trading above parity with the U.S. dollar a year ago, is now just below 80 cents (U.S.).

It's an argument that not all economists are buying. In theory, a softer currency encourages recovery because it makes a country's exports cheaper to the rest of the world. But the main buyers of Canada's exports are hard-hit U.S. consumers, and they are showing no signs of picking up their demand just because of a lower loonie.

A recovery, some say, could be at least a year away. In a forecast released yesterday, Dale Orr, chief economist at Global Insight Canada, said he doesn't see Canada's economy returning to full speed until the end of 2010 - at the earliest. He expects it will contract 0.4 per cent in 2009, before rebounding to 2.9 per cent in 2010.

"This implies impending layoffs, stagnant wage rates and/or declining profits ahead," he warned, calling the bank's cut "a good defensive move."

The best hopes for recovery lie in forceful measures from both the central bank and the federal government, said Paul-André Pinsonnault, senior fixed income strategist at National Bank Financial. If interest rates fall further to 1.25 per cent, and governments give a fiscal boost worth 1.5 per cent of the country's gross domestic product (about $22-billion), "that will be sufficient to kick-start the economy," he said.

(prepared by Heahter Schoffield/Globe & Mail)