Bank of Canada may cut rates again this month

By Randall Palmer - Analysis

OTTAWA (Reuters) - The Bank of Canada may well cut its benchmark interest rate again on October 21, adding heft to a surprise reduction Wednesday that came as part of a coordinated global response to a tightening squeeze on credit.

The central bank itself, in a statement that accompanied its announcement, seemed to leave the door open for further cuts, saying it would carefully monitor events "in judging whether further action might be required."

It stressed the potential for weaker growth as a result of lower demand from the United States, which consumes most of the country's exports, and a deterioration in the terms of trade. The bank also suggested inflation had receded as a concern.

On the heels of a half-point cut in the bank's overnight rate to 2.5 percent, private economists are being unusually tentative in predicting the next move, due on its next scheduled date in two weeks. That may reflect the erratic reaction by investors to Wednesday's cut, one of several by central banks around the world.

Even so, markets are pricing in a cut of at least half a point in Canada. Part of the reason is credit conditions have not loosened very much, analysts say.

The Canadian Dealer Offered Rate, the interbank rate best reflecting banks' cost of funds and their lending rates, was 3.31 percent on Wednesday morning -- down from Tuesday but still higher than a month ago, Merrill Lynch Canada chief economist David Wolf pointed out.

"Effectively, then, the monetary policy setting is no more accommodative now than it was then despite overnight rates being 50 basis points lower, as reflected in recently higher mortgage rates and the potential reluctance of the banks to drop their prime rates later today to match the (Bank of Canada's) move," he said.

After the central bank's cut, Canada's big banks said they would pass along only part of the reduction to borrowers, lowering their prime rates by only a quarter point.

Scotia Capital economists Derek Holt and Karen Cordes, who have forecast a Canadian recession, are among those expecting a half-point cut on October 21.

"We ... foresee significant further interest rate reductions by all major central banks than we had previously forecast," they said in a note to clients.

"Impaired global interbank funding channels mean that rates have to be hit much harder than would otherwise be the case in order to have any hope of passing through to the end borrower as a material easing of monetary conditions."

Based on overnight index swaps, there is a 71 percent probability the central bank will reduce the overnight rate to 2 percent on October 21 and a 29 percent probability of a deeper cut.

To be sure, if markets settle down and interbank money starts moving more fluidly, Bank of Canada Governor Mark Carney may take pause.

"We've seen this unprecedented intervention from monetary authorities and fiscal authorities around the globe, and at some point you'd think it stabilizes confidence and turns the tide in sentiment and hopefully also eases some of the strains in credit markets," RBC chief economist Craig Wright said.

RBC earlier on Wednesday cut its forecast for Canadian growth this year to 0.9 percent from 1.4 percent. It sees a rebound to 1.5 percent next year.