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Bank Of Canada Likely To Cut Interest Rates

Central bank tries to stabilize markets

EDIT: FOR A MORE RECENT ARTICLE ON INTEREST RATES, CLICK HERE

Failure of cash infusion to stop decline means bank will likely cut interest rates

Eric Beauchesne

CanWest News Service
Thursday, August 16, 2007

OTTAWA — The Bank of Canada, in a new bid to reassure panicky investors, yesterday accelerated its efforts to pump more money into domestic financial markets, which are being roiled by a deepening global credit crunch.

Its unprecedented move, however, did not prevent another steep drop in the Canadian dollar and stock market, both of which plunged further to their lowest levels in three months.

The bank announced it will temporarily accept some non-federal government securities as collateral for its one-day loans to financial institutions to ease the credit crunch in Canada. The public announcement came a day after some issuers of commercial paper were temporarily unable to raise funds to refinance billions of dollars in maturing issues.

The action is a “step in the right direction” but may not be enough for financial systems “under significant stress,” said Clement Gignac, chief economist at the National Bank of Canada, which in the wake of the credit crunch has boosted its odds of a U.S. recession to 50-50. The chances of a recession in Canada are no more than 30 per cent because of the country’s healthy public finances, stronger housing market and its status as a net exporter of natural resources, Gignac said.

Gignac said yesterday’s cash infusion increases the chances that the Bank of Canada will also have to cut interest rates rather than increase them further as it suggested it would next month. Central banks in Canada and the U.S. will have to change their focus from fighting inflation to stimulating their economies, he said.

The actions by the Bank of Canada, which matches those taken by the Fed last week, came as the Canadian dollar slipped below 93 cents US, down more than three cents from last month’s triple-decade high of over 96 cents US.

The loonie ended the day at 92.78 cents US, its lowest level since May, and down from 93.75 cents US Tuesday. Meanwhile, Bay Street’s benchmark stock market index plunged nearly 200 points, and Wall Street’s fell nearly 170 points.

“As part of its continuing provision of liquidity in support of the efficient functioning of financial markets, the Bank of Canada … is temporarily expanding the list of collateral eligible for use by market participants in special purchase and resale agreements,” the bank said in a statement.

The expanded list — which includes provincial and local government, and some corporate securities — will remain in effect until further notice, the bank said.

Late last week, the bank for the first time since the 2001 terrorist attack on the U.S. publicly reassured markets that it would provide enough liquidity to support financial markets through one-day purchases of securities from financial institutions, leaving them with extra cash for lending.

Yesterday, the bank injected $350 million into the financial system, about half the amount it pumped into the system at the start of the week and only a fraction of the roughly $1.6 billion it injected in each of the final two days of trading last week. The U.S. Fed, meanwhile, plowed $7 billion US into that country’s financial system to meet demands for cash by the U.S. financial system.

Finance Minister Jim Flaherty’s office did not respond yesterday to queries on the financial market crisis, but Prime Minister Stephen Harper, following this week’s cabinet shuffle, stressed that Canada is in good enough economic and financial shape to weather the current storm.

“Canada will not be immune to fluctuations in the international marketplace nor will individual firms be immune,” Harper said. “That said, we should be very clear the fundamentals of the Canadian economy are very strong as are the fundamentals of our banking and financial sector generally.”

Adding to the view that a rate hike in Canada next month is now off the table were Statistics Canada reports that Canadian factory shipments and new car sales weakened in June.

Manufacturing shipments tumbled in June, falling 1.8 per cent to $48.6 billion, the third straight drop and the steepest since January, Statistics Canada reported. Shipments during the first six months of the year were up just 0.1 from the same period last year.

The decline in shipments was led by autos.

“Soft conditions in the U.S. auto market are taking their toll,” said National Bank of Canada economist Marc Pinsonneault. “Looking ahead, and given our belief that U.S. consumption expenses will remain lackluster in the coming quarters, conditions should remain challenging for that industry.”

But Canadian auto sales are also weakening, according to separate Statistics Canada report.

During June, new auto sales also slipped 1.2 per cent in June to 143,900, the second straight monthly decline, although they remain at historically high levels, Statistics Canada said in a separate report.

© Times Colonist (Victoria) 2007