Rita Trichur
Business Reporters
The Bank of Canada slashed its key interest rate yesterday by three-quarters of a percentage point to the lowest level in half a century and confirmed Canada's economy is "entering a recession" because of the deepening global economic slump.
But chartered banks refused to match the deeper-than-expected cut, dropping their prime rates by only half a percentage point, the second time in the past few months some have balked at passing on the full savings to consumers and businesses.
Canada's benchmark overnight rate now stands at 1.5 per cent, the lowest since 1958, as the Bank of Canada tries to revive the flagging economy and restore confidence by making it cheaper to borrow money.
The rate reduction was the single-biggest cut since the aftermath of the 2001 terrorist attacks in the United States.
"The outlook for the world economy has deteriorated significantly and the global recession will be broader and deeper than previously anticipated," the central bank stated, adding that global financial markets "remain severely strained."
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It also hinted more rate cuts may be in the offing and some economists now expect the overnight rate to fall to 1 per cent early in 2009.
"Clearly the bank is signalling that they want to address the downturn in the economy much more aggressively and much more quickly," said Douglas Porter, deputy chief economist at BMO Capital Markets.
But the "half-hearted" response of the chartered banks raised concerns they may be undercutting the Bank of Canada's efforts to stimulate the economy at a time when worries are growing that some central banks are running out of room to cut.
Toronto Dominion Bank, Canadian Imperial Bank of Commerce, Royal Bank of Canada, Bank of Nova Scotia, Bank of Montreal and the National Bank of Canada all lowered their prime lending rates – the rates they charge their most creditworthy customers – from 4 per cent to 3.5 per cent.
In early October, the TD Bank and CIBC declined to fully match a half-point rate cut by the Bank of Canada, citing soaring funding costs. Both lenders later moved to fully match their rivals when another quarter-point cut was delivered two weeks later.
Erin Weir, an economist with the United Steelworkers union, said the issue goes beyond "consumer outrage." He argued the chartered banks' latest rebellion poses a serious "existential threat" to monetary policy.
"If the chartered banks don't respond to the Bank of Canada's rate, then monetary policy is completely ineffective."
If banks require more capital, Weir argues the federal government should look at buying equity stakes in those lenders as other governments have done.
Tsur Somerville, a professor at the Sauder School of Business at the University of British Columbia, noted that spreads have been increasing between conventional five-year mortgage rates and corresponding government bond rates. But he noted this is "not inconsistent" with the major recessions of the early 1980s and mid-1970s.
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"It does limit the immediate effect of monetary policy, but the flip side of that is when people are extremely paranoid, even if interest rates are low, they're not borrowing," Somerville said. "If I'm being laid off my job, the fact that mortgage rates have come down 50 basis points – you know what, I'm probably still not going to go out and buy a house."
Last week, Canada's six biggest banks wrapped up their latest earnings season. Their combined annual profits tumbled to slightly more than $12 billion from a record $19.5 billion last year, largely because of debt-related writedowns. More flexible accounting rules, however, helped them avoid even bigger losses.
Still, their latest prime rate decision outraged some Members of Parliament.
Liberal consumer affairs critic Dan McTeague said the move amounts to poor optics given all the support Ottawa has provided to shore up lending. The federal government has tripled the size of its mortgage purchase program to $75 billion and has agreed to backstop more than $200 billion in interbank lending.
"This is not about bank bashing. This is about recognizing the pivotal role they play in terms of securing our strong economy in very difficult times," McTeague said.
NDP finance critic Thomas Mulcair said he informed the Canadian Bankers Association that he would call for an investigation under federal competition laws, as he questioned why all six banks dropped their prime rates by exactly 50 basis points.
"Canada's banks are governed by the laws of Canada," the CBA said in a statement. "Canada's banks take compliance with those laws very seriously. Decisions about prime rates are proprietary in nature and are made following individual bank internal procedures."
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