OTTAWA -
The Bank of Canada slashed its key interest rate to the lowest level in history Tuesday, pronouncing the country has fallen into recession and needs help to recover.
The central bank cut the trend-setting overnight rate by one-half point to one per cent -- below the previous policy rate low of 1.12 per cent in 1958 -- while drastically revising downward its view of economic performance this year.
The decrease was in line with the expectations of economists, who have been calling for bold action by the central bank and the federal government in light of the quick and sharp downturn last fall that followed the disorder on global stock markets.
Shortly after the central bank cut its rate, the big commercial banks reduced their prime lending rates by the same amount. Prime, the benchmark for a wide variety of loans, now stands at three per cent.
There also was mortgage-rate relief, with banks announcing reductions of as much as 1.1 percentage points on selected terms.
Bank of Canada governor Mark Carney made clear that the economy needs all the help it can get.
While he had previously declared publicly that the economy is in recession, on Tuesday he reversed the bank's previous forecast of 0.6 per cent growth for 2009 into a 1.2 per cent retreat.
"The outlook for the global economy has deteriorated since the bank's December interest rate announcement, with the intensifying financial crisis spilling over into real economic activity," Tuesday's statement said.
"Heightened uncertainty is undermining business and household confidence worldwide and further eroding domestic demand."
In Canada, "exports are down sharply and domestic demand is shrinking as a result of declines in real income, household wealth and consumer and business confidence."
As if to confirm this bleak assessment, Statistics Canada reported that manufacturing sales fell 6.4 per cent in November to the lowest level in four years.
Both the Toronto Stock Exchange and the Canadian dollar took it on the chin Tuesday, with the S&P/TSX composite index tumbling 336.55 points to 8,504.93 and the loonie losing 0.81 cent to 78.89 cents US.
The Bank of Canada's relatively rosy medium-term outlook for the economy surprised many private-sector economists.
It forecast that growth will bounce back to a rate of 3.8 per cent in 2010, thanks to aggressive actions of central bankers and governments to inject liquidity and stimulus.
"I think they are overly optimistic on the speed of the rebound," commented Scotia Capital economist Derek Holt.
Global Insight managing director Dale Orr added that the ball is now in the federal government's court, saying next Tuesday's budget should contain significant temporary stimulus.
With the one per cent target for the overnight rate, the Bank of Canada is nearing the end of its ability to affect interest rates by conventional means.
Since December 2007, it has chopped the overnight rate by 3.5 percentage points, as well as injected $35 billion into money markets through asset swaps.
Next up is fiscal stimulus in the budget. Government officials have said Finance Minister Jim Flaherty plans as much as $30 billion -- equivalent to two per cent of gross domestic product -- in infrastructure spending and tax cuts.
But Carney said the key test remains the availability of credit, and the world economy won't recover until the financial system, rocked by scandal and reckless lending practices, stabilizes.
Although the chartered banks quickly followed Tuesday's rate cut, long-term loans are widely perceived as relatively expensive and difficult to obtain.
In Tuesday's mortgage moves, the Royal Bank of Canada (TSX:RY) slashed its one-, two- and three-year rates by 1.1 percentage point. Its five-year posted rate drops 0.96 point to 5.79 per cent, and there is a five-year closed special offer of 4.49 per cent.
Scotiabank (TSX:BNS) followed with generally less drastic cuts of 0.2 to 0.7 point, with its five-year posted rate down 0.3 point to 6.45 per cent.
Scotia Capital economist Holt is urging the government to help free up lending through a number of measures, including backstopping car leasing and possibly purchasing faltering non-mortgage loans.
But not all agree. "I don't think they go there until the Bank of Canada goes down to zero or near-zero interest rate," said Douglas Porter, deputy chief economist with BMO Capital Markets.
Many economists see the central bank lowering its rate to 0.5 per cent as early as March 3.
One problem Carney won't have to worry about for some time is inflation.
The central bank now expects prices will actually tumble into negative territory for two quarters this year as the contrast between last summer's sky-high gasoline prices and this year's much lower levels pushes the headline inflation rate down.
Economists do not view this as deflation -- an alarming condition that plagued Japan in the 1990s -- because it is not expected to be prolonged and is concentrated in energy costs.
Overall, the Bank of Canada predicts inflation will average 1.1 per cent this year and won't return to the bank's two per cent target until 2011.
