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• The Bank of Canada delivered one last 25bps rate cut today to leave the overnight rate at an effective floor of 0.25%.

• Using a surprising degree of transparency, the Bank stated that it will leave the overnight rate there until June 2010 to flatten the yield curve.

• The Bank also downgraded its economic forecasts for both 2009 and 2010.

• The comments on policy alternatives did not include much detail, but they opened the door to quantitative easing and we expect more on that front when the Bank releases the Monetary Policy Report on Thursday.

The Bank of Canada cut the overnight rate by 25bps to 0.25%. We had predicted this outcome but the market was split on the decision. The Bank noted that this is the floor for the overnight rate, suggesting that rates will go no lower. What did come as a surprise though was the astonishing transparency by the Bank as it explicitly stated that rates will remain at this level until June 2010. This level of transparency is unprecedented but it speaks to the dire state of the economy and a desire to control expectations.

In the communiqué, the Bank admitted that given the synchronized nature of the recessionary headwinds, the global economic downturn has intensified. As such, the recession in Canada has also “been deeper than anticipated.” The Bank further downgraded not only its economic forecast, but also its estimate of potential growth. GDP in 2009 now expected to contract by 3.0%, which is lower than the 1.2% drop anticipated in January. The recovery is not expected to occur until the fourth quarter.  In 2010, the Bank now expects GDP to advance 2.5%, compared to 3.8% reported in the January MPR Update. In terms of inflation, the Bank expects core inflation pressures to subside through 2009. Core inflation should only return to the Bank’s 2% target by the third quarter of 2011. Headline CPI is expected to bottom out at -0.8% in Q3 2009 and should return to the 2% target by the third quarter of 2011. And even with these downgraded forecasts, the Bank still highlighted downside risks to these numbers, suggesting that there is indeed a lot of uncertainty.

Aside from the downgraded forecasts, the other focal point for the statement was contained in the Bank’s verbiage on possible alternatives to monetary policy. They did not provide much in that regard. The Bank did note however, that “with monetary policy now operating at the effective lower bound for the overnight policy rate, it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities.” We can expect more detail on Thursday when the MPR is released.

We are of the view that the Bank may eventually employ quantitative easing, but it needs to set out a framework first, which will occur on Thursday. Once that is done, the Bank can use these alternative policy tools at their discretion. Nothing is likely to happen immediately as the Bank “retains considerable flexibility in the conduct of monetary policy at low interest rates, consistent with the framework to be outlined in the Bank's Monetary Policy Report on 23 April.”

Globe and Mail Update

April 21, 2009 at 11:16 AM EDT

OTTAWA — The Bank of Canada cut its benchmark lending rate to the lowest possible, and promised to leave it there for as long as a year in order to fight a recession that is deeper and will last longer than previously thought.

The central bank on Tuesday dropped its key overnight target a quarter-percentage point to 0.25 per cent, which is “the effective lower bound” because anything deeper would disrupt short-term money markets, policy makers said in a statement.

In January, Bank of Canada Governor Mark Carney was counting on multibillion-dollar stimulus programs pledged by governments in the Group of 20 major economies to reverse the effects of the financial crisis by the third quarter of this year. Those policies are taking longer roll out than policy makers anticipated, a delay that's exacerbating the downturn.

“The global recession has intensified and become more synchronous since the bank's January Monetary Policy Report Update with weaker-than-expected activity in all major economies,” the statement said. “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 central bank now predicts that Canada's gross domestic product will shrink by 3 per cent in 2009, compared with a January estimate for a 1.2-per-cent contraction.

The Bank of Canada also abandoned its relatively optimistic estimate that the economy would rebound to expand 3.8 per cent in 2010. The recovery will be far more muted, with an expansion of 2.5 per cent in 2010, the central bank said.

Mr. Carney and his chief advisers on the governing council are trying to restore confidence amid Canada's first recession since 1992. Employers have shed more than 270,000 jobs since the country fell into a recession in the fourth quarter, a period during which factories produced at only 75 per cent of their capacities, the lowest rate on record.

As troubling for the policy makers is an inflation rate that they said Tuesday will crater to an annual rate of negative 0.8 per cent in the third quarter.

The Bank of Canada is mandated by law to keep inflation advancing at a rate of about 2 per cent a year. That target won't be reached until the third quarter of 2011, the central bank said.

“Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target,” the statement said.

That commitment is unusual for Canada's central bank, which typically is more circumspect in order to retain a degree of command over investors.

With the target rate at a bottom, Mr. Carney is being forced to pull back the curtain so investors better understand the trajectory of monetary policy.

By pledging to keep the benchmark rate low for a long time, policy makers are telling investors that they can safely price mortgage rates, corporate debt and other credit assets based on the 0.25 per cent target.

Without that certainty, investors might have been reluctant to lower longer rates.

“The Bank of Canada doesn't guarantee that it won't raise rates for a year, but its implicit message is that it sees that risk as very low given current economic slack,” Avery Shenfeld, a senior economist at the CIBC World Markets, said in a note to clients.

Many analysts said before Tuesday's release that they thought Mr. Carney would leave the overnight target unchanged to avoid the technical headaches of adjusting a rate that was already so close to zero.

The overnight target is the rate at which the Bank of Canada encourages financial institutions to lend to each other at the end of the day when they settle their accounts.

Ultimately, commercial lenders who need either a short-term loan or a place to park excess funds at the end of the day can turn to the central bank. To encourage private institutions to balance these funds themselves, they charge 0.25 per cent more than the target on loans, and pay 0.25 per cent below the target on deposits.

Tuesday's decision makes the target and the deposit rate one and the same.

The Bank of Canada left the deposit rate unchanged at 0.25 per cent because a rate of zero would have made lending in short-term money markets unprofitable.