Bank of Canada’s hand likely forced by Federal Reserve’s emergency rate cut – USA DAILY NEWS

Bank of Canada’s hand likely forced by Federal Reserve’s emergency rate cut

COVID-19 has the world’s central banks back in crisis mode.

Jerome Powell, chair of the U.S. Federal Reserve, watched stocks drop for less than half an hour at the start of trading on March 3 before pulling the trigger on an emergency interest-rate cut of half a percentage point. Earlier, the Reserve Bank of Australia dropped its benchmark rate to to 0.5 per cent, its lowest level ever. Malaysia’s central bank also dropped borrowing costs.

“The fundamentals of the U.S. economy remain strong,” the Fed’s policy committee said in a statement. “However, the coronavirus poses evolving risks to economic activity,” it added, emphasizing that it might not be finished. “The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.”

For a moment early on Tuesday, it looked as if the central banks were satisfied with standing at the ready. An extraordinary call of the top economic officials from the Group of Seven ended without extraordinary action.

Finance ministers and central bankers from the United States, Japan, Germany, France, the United Kingdom, Italy and Canada said they would “use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.”

But unlike October 2008, when the G7 orchestrated synchronized interest-rate cuts, the group did not backup its words with policy. They pledged to do whatever it takes to prop up their individual economies when the time comes. That time didn’t seem to be in the immediate aftermath of their telephone call.

The absence of actual interest-rate cuts, or even hard numbers on how much finance ministers might be willing to spend, tested the credibility of the core group that fought the financial crisis. Stocks plunged when markets opened, suggesting the G7 might lack the authority it has possessed in the past.

United ahead of the cataclysmic events of 2008, it was impossible to ignore that the chair of the G7 call — Steven Mnuchin, the U.S. secretary of the treasury — was a member of an administration that has been fighting the others on trade and climate change for the past four years. The core message — “all appropriate tools” will be used — was essentially the same as the one the Fed, Bank of Japan, Bank of England and European Central Bank had already delivered over the previous few days. Those pledges stoked a stunning rally in global stock prices. The absence of an equally forceful follow-up could have resulted in a letdown.

“The G7 is signalling that there is a policy backstop, even if its statement lacks specifics,” said Sophia Drossos, a former Fed economist and Wall Street currency strategist who now runs her own consultancy. “The markets might test the resolve of policy-makers in the near term, but it seems to me that officials are prepared to act.”

Indeed. The Fed was next scheduled to update its policy on March 18. The decision to break with its calendar demonstrates a degree of worry that mirrors that of traders, and will raise questions about why the G7 central banks didn’t act in unison when they had the chance. The answer could simply be that the stakes are higher for the Fed and that it had a clear path to introduce stimulus. The benchmark interest rate in the U.S. was around 1.5 per cent, whereas the Bank of Japan’s policy rate is essentially zero and the ECB’s is negative.

Jerome Powell, chairman of the U.S. Federal Reserve, pauses while speaking during a news conference in Washington, D.C., U.S., on Tuesday, March 3, 2020.

Jerome Powell, chairman of the U.S. Federal Reserve, pauses while speaking during a news conference in Washington, D.C., U.S., on Tuesday, March 3, 2020.

Andrew Harrer/Bloomberg

The G7 statement said central banks “will continue to fulfil their mandates, thus supporting price stability and economic growth while maintaining the resilience of the financial system.” The Fed decided within two hours of signing that pledge that it had to act immediately.

“The usual Fed put kicked in to compensate in part for the tightening of financial conditions,” Sebastien Galy, a strategist at Nordea Asset Management, said in an email to clients, referring to the widely held notion that the U.S. central bank will only tolerate so much market volatility. However, the cut was “mostly to avoid fear spreading like a disease through the economy as firms increasingly deal with shortages of parts,” he said.

If the game plan is coordinated stimulus, then the Bank of Canada is up next.

Most of Bay Street had decided the Canadian central bank would cut interest rates on March 4, but there were holdouts who argued that Governor Stephen Poloz and his deputies might prefer more data in order to gauge the scale of the threat. The Bank of Canada’s counterparts have now done that on its behalf.

As G7 officials readied for their call, the Reserve Bank of Australia had already dropped its benchmark rate a quarter point. “The coronavirus outbreak overseas is having a significant effect on the Australian economy at present, particularly in the education and travel sectors,” Philip Lowe, the bank’s governor, said in a statement. “The uncertainty that it is creating is also likely to affect domestic spending.”

The bank’s assessment probably would have been enough to convince the Bank of Canada that the time for stimulus had come. The Fed cut settled the matter. On March 2, Veronica Clark, an economist at Citibank, thought Poloz might decide to wait until later this spring to cut interest rates. On March 3, she changed her call to a half-point reduction this week.

“We expect the BoC to follow suit,” Clark said in a note to clients. “We expect the action tomorrow will be part of a more-coordinated response in line with the Fed.”

Financial Post