INTEREST RATES: Cental Bank promises year of rock-bottom rates

The Bank of Canada is trying a new weapon in its struggle against the recession: transparency.

In an uncommon display of openness, Canada's central bankers said yesterday that they intend to leave the benchmark lending rate at a record low of 0.25 per cent for as long as a year.

With conventional methods of policy-making all but exhausted, Governor Mark Carney is exploring new ways to instill confidence in an economy battered by the financial crisis and a collapse in demand for exports.

Yesterday's pledge by the central bank to keep the overnight target rate "at its current level until the end of the second quarter of 2010" will allow private lenders to set prices for mortgages, credit lines and other loans without fear that the central bank will suddenly reverse course – a degree of certainty that could loosen tight credit markets.

The economists who make a living trying to decipher Mr. Carney's often cryptic messages were stunned by the central bank's decision to yield its power to surprise.

Toronto-Dominion Bank's Grant Bishop called the move "terrific," and Paul-André Pinsonnault at National Bank Financial in Montreal said he is unaware of any other central bank that's set out such an explicit trajectory for interest rates.

"It's unprecedented in terms of transparency," said Dustin Reid, a currency strategist at RBS Securities in Chicago and a former economist at the Bank of Canada. "Historically, central bankers have been reluctant to share their inside thoughts so the markets don't get ahead of them."

Mr. Carney's decision to lift the shroud over his thinking about interest rates is being driven by the recession, which the central bank said yesterday will be deeper and last longer than it had thought.

Facing weaker prospects, the Bank of Canada dropped its key overnight target a quarter percentage point to the lowest it can go without disrupting short-term money markets.

The central bank has now slashed borrowing costs by 4.25 percentage points since December of 2007.

But the conventional approach of slashing interest rates to spur growth hasn't been enough to reverse the downturn.

Even with a record low overnight rate, the central bank's April 13 survey of loan officers found those who said credit was more expensive outnumbered those who said it was cheaper by 80 percentage points, the biggest margin in the history of the survey.

Canada's gross domestic product will shrink 3 per cent this year, compared with Mr. Carney's prediction in January of a milder 1.2-per-cent contraction, and the rebound now will come in the fourth quarter instead of the third, the Bank of Canada said.

In another example of frankness, policy makers conceded they had put too much faith in the belief that governments in the Group of 20 major economies would deliver quickly on pledges to spend tens of billions fighting the recession.

That realization also forced the Bank of Canada to abandon its relatively optimistic estimate that the economy would rebound to expand 3.8 per cent in 2010, lowering its estimate to 2.5 per cent.

"The global recession has intensified and become more synchronous," the central bank said in the press release explaining its latest policy decision. "While more aggressive monetary and fiscal policy actions are under way across the G20, measures to stabilize the global financial system have taken longer than expected to enact."

The Bank of Canada's new forecast for 2009 is dramatically different from the 0.8-per-cent contraction Finance Minister Jim Flaherty used as a basis for his January budget, which projected deficits until 2013 to accommodate a $40-billion stimulus program.

Mr. Flaherty told reporters in Ottawa yesterday that he remains "comfortable" with his outlook, noting that he built a cushion into his budget calculations on the assumption that economic conditions would continue to deteriorate.

"We're still on track, but we're going to watch carefully as the year goes on," Mr. Flaherty said.

The collapse in growth is making it difficult for Mr. Carney to fulfill his mandate to keep inflation advancing at about 2 per cent a year.

Yesterday, the Bank of Canada said consumer prices would fall at a rate of 0.8 per cent in the third quarter, and inflation won't return to the target until the third quarter of 2011.

Mr. Carney's need to persuade consumers, investors and businesses that he's committed to the inflation target is one reason for setting out a clear path for interest rates.

In the statement, policy makers said the only thing that would cause them to raise interest rates would be a surprise burst of inflation. They pledged to provide guidance on their inflation outlook at their scheduled policy meetings. The next one is June 4.

"It's a lot easier to proceed with investment decisions, consumption decisions when you feel comfortable you're not going to get blindsided," said Darcy Briggs, vice-president and portfolio manager at Bissett Investment Management in Calgary.

The Bank of Canada's commitment to transparency next will be tested tomorrow when Mr. Carney is set to release a plan for how policy makers would go about lowering interest rates by becoming buyers of financial assets, a strategy referred to as credit and quantitative easing.

Policy makers appeared to signal yesterday that the release will be an academic exercise, saying in the statement that interest-rate cuts and the pledge to keep borrowing costs low "is the appropriate policy stance to move the economy back to full production capacity and to achieve the 2 per cent target."

If that is the message, many in financial markets weren't ready to accept it.

"It's more likely than not," said Mr. Reid, noting that the Bank of Canada is the only major central bank that hasn't yet begun some kind of quantitative-easing campaign. "It's like running all the way to the finish line and not going over. Not doing it now would look a bit odd."

(prepared by Kevin Carmichael/Globe & Mail)