Measures to combat credit crunch

The Bank of Canada, along with the U.S. Federal Reserve, European Central Bank and others, announced an interest rate cut of 50 basis points last Wednesday. The Bank of Canada’s benchmark lending rate now stands at 2.5 per cent.

The U.S. Fed cut its benchmark rate by a half point to 1.5 per cent, while the European Central Bank and central banks in the U.K., Sweden and Switzerland are also reducing rates.

The Bank of Canada said deteriorating credit conditions, weaker demand and the drop in commodity prices will “significantly” ease inflation pressures in Canada.  

“The intensification of the global financial crisis is having a marked impact on all countries," the bank said in a statement, adding credit conditions in Canada have tightened significantly in recent weeks and that slowing consumer spending and business investment will pull economic growth lower.

“Central banks are further lowering forecasts for economic growth and inflation due to intensifying fallout from the global credit crunch,” said Canadian Real Estate Association chief economist Gregory Klump. “Had the U.S. Federal Reserve acted alone in cutting U.S. interest rates, the Canadian dollar would have appreciated. 

“The co-ordination of a surprise cut in interest rates prevented the Canadian dollar from rising,” he added. “A higher Canadian dollar would have dragged Canadian exports lower at a time when global demand for them is dropping.”

Meanwhile, the federal government’s announced purchase of $25 billion in residential mortgages from Canadian banks has prompted some banks to further lower mortgage interest rates. 

The government is scheduled to purchase “insured mortgage pools” through Canada Mortgage and Housing Corporation — mortgages already insured by CMHC are considered to be “high-quality assets.” This means there is no risk associated with the mortgage purchase for Canadian taxpayers, according to Ottawa.

The government assured the Canadian public that Canada’s banks, unlike those in other countries, are sound as they weren’t involved in the sub-prime mortgage fiasco. But, Canadian banks have become entangled in the resulting credit crunch spurred on by  U.S. and European countries which were heavily involved in sub-prime mortgages. The fallout from the crisis has made it more difficult for Canadian banks to borrow funds on the world financial market without paying high rates in order to fund their own lending practices, including mortgages.

The reason for the Canadian government’s purchase from the banks was to ensure a supply of mortgage funds are available to home buyers. Through its phased-in purchase, the government is encouraging the banks to issue more CMHC-insured mortgage loans.

A CMHC press release said the purchase is designed “to maintain the availability of longer-term credit in Canada.”

According to CMHC, the first mortgage purchase of $5 billion will be made this week through a competitive auction. The Canadian government will announce future auctions over the coming weeks.

Japan supported the global effort, but did not cut its benchmark rate, which already stands at 0.5 per cent.

China also announced an interest rate cut, the country’s second in three weeks. Hong Kong cut its rates by 100 basis points. The moves in China and Hong Kong were not part of the officially co-ordinated effort.

The Bank of Canada sets its interest rates with an eye at keeping inflation at two per cent. The bank said it would continue to monitor carefully economic and financial developments in determining whether “further action” is necessary.

The Bank of Canada's decision to join the other central banks in a co-ordinated rate cut suggests credit conditions in Canada have deteriorated rapidly. 

In a speech less than two weeks ago in Montreal, the Bank of Canada governor, Mark Carney, said there were “few signs” that Canadian banks were restricting the availability of credit to households.

“There is no evidence at this point that our corporations are facing unusual credit conditions,” he told a recent business luncheon in Montreal.

The Bank of Canada’s governors are scheduled to release their next interest rate decision on October 21.