Financial Update

Chartered banks reluctantly follow Bank of Canada in interest rate cut

· TSX -54.82 (Reuters) – The main index closed lower,ending a 6-session rally, amid disappointing corporate results and comments from the Bank of Canada that U.S. economic prospects were worse than previously thought.

· Dow -104.79

· Dollar -.19c to $ $99.21US

· Oil +$1.44 to a new record of $118.07US per barrel .

· Gold +$7.60US to $922.30US

Bond Rates: http://www.bankofcanada.ca/en/rates/bonds.html <http://www.bankofcanada.ca/en/rates/bonds.html>


By Julian Beltrame, The Canadian Press

OTTAWA - The Bank of Canada slashed interest rates by half a percentage point Tuesday amid worrying signs that the economic slowdown could be steeper and longer than previously thought.

It was second time in as many months that new bank governor Mark Carney has moved aggressively on interest rates, bringing down the key overnight rate to three per cent, one-and-a-half points below where it was at the start of December.

But in an unusual reaction, Canada's chartered banks delayed for most of the day matching the central bank's reduction, suggesting growing unease with the state of financial markets.

The Toronto-Dominion Bank was first to act, after 5 p.m. ET, announcing a 50 basis rate cut to its prime lending rate to 4.75 per cent, followed by the other four big Canadian banks.

"It's a fair question to ask if monetary policy is losing its steam," said Dale Orr, managing director of Global Insight Canada. He noted that the last time the bank cut the rate by 50 basis points on March 4, short-term lending rates dropped in response, but five-year, and 10-year bond rates actually went up.

The Canadian Real Estate Association offered further evidence consumers are not receiving the full benefits of monetary easing. The group said five-year conventional mortgages in Canada were 6.99 per cent prior to the central bank's latest action, just slightly above where they stood a year ago.

"There's a cost of funds issue that no doubt the banks have to wrestle with - the banks are reluctant to lend to each other because there's a default risk," TD Bank chief economist Don Drummond explained.

"We tend to think that the bank rate tends to set all the cost of funds, and it normally does, but it certainly hasn't been doing that lately."

In an explanatory statement of its action, the central bank did not mince words that its expectations for the economy have darkened and that it would probably need to cut rates at least once more to provide needed stimulus.

The bank said Canada is in for two relatively lean years and the economy would not fully recover until mid-2010.

"The bank is now projecting a deeper and more protracted slowdown in the U.S. economy," it said in a statement.

"This has direct consequences for the Canadian economic outlook, with declining exports projected to exert a significant drag on growth in 2008."

The Canadian dollar slumped almost three-quarters of a cent in reaction, but recovered most of those losses to close at 99.21 cents U.S., down 0.19 cents.

While some economists said the steep reduction was necessary, several questioned whether former governor David Dodge, who had praised the measured approach at his leave-taking in late January, would have reacted in similar fashion.

"It's quite possible we may have had a different decision under David Dodge, but we'll never know," said BMO deputy chief economist Douglas Porter.

While avoiding using the word recession, the bank's statement presented a gloomy picture of the global, U.S. and Canadian economies as they struggle to overcome the ongoing turmoil in financial markets caused by the U.S. subprime mortgage crisis.

The global economy has weakened, the bank said, and because of the slump in the U.S., Canadian exporters will find many of their traditional markets have dried up. But tight credit conditions and softening confidence will also slow down business investment and consumer spending, it added.

It projected growth at 1.4 per cent this year and 2.4 per cent next year, a significant downward revision from last January's modest growth expectations of 1.8 per cent and 2.8 per cent. The economy will finally bounce back in 2010, it said, to record a 3.3 per cent rate of growth.

Still, that's far from a recession. What will keep Canada's economy above water, the bank said, is relatively strong domestic demand supported by high commodity prices, strong employment and stimulus provided by lower interest rates.

Porter said the bank's stark language would justify such a deep cut, although he questioned whether the situation is as bleak as the central bank suggests.

"But given that Canadian inflation is so far below two per cent, the bank has the luxury of over-insuring the economy against downside risk," he said. "They've taken out a huge insurance policy. Maybe they have too much insurance, but the upside risk on inflation is relatively mild at this point."

The central bank said that the rate of price increases has been running at about 1.5 per cent in recent months and is expected to remain below its two per cent target throughout this year and next.

The bank's next announcement for the target rate is scheduled for June 10, when many expect it will make its last adjustment this year by shaving the overnight rate to 2.75 per cent.

Financial Update

Bank of Canada Cuts Rate by 50 Basis Points as Economy Slows

April 22 (Bloomberg) -- The Bank of Canada lowered its benchmark rate by half a point to revive an economy that's growing at its slowest pace in 16 years and signaled more easing may be needed. The rate on overnight loans <http://www.bloomberg.com/apps/quote?ticker=CABROVER%3AIND> between commercial banks dropped to 3 percent, the lowest since December 2005, as forecast by 28 of 32 economists in a Bloomberg survey.

· TSX continued to climb for the 6th day in a row +84.10

· Dow -24.34.

· Dollar -.11c to $ $99.40US

· Oil +$.79 continuing to break new records $117.48US per barrel

· Gold +$2.50US to $914.70US

Bond Rates: http://www.bankofcanada.ca/en/rates/bonds.html <http://www.bankofcanada.ca/en/rates/bonds.html>


Below is an informative piece from Saturdays National Post on what will happen to interest rates after both the Bank of Canada and the US Fed drop their predicted .50% on the overnight lending rate, broken down by fundamental, season and technical influences.


U.S. rates likely to bottom in spring

Comment; That will be good for the U.S. dollar but bad for bonds Don Vialoux, Financial Post

Central bank interest-rate changes will be a focus for investors during the next two weeks. The Bank of Canada is expected to preempt the Federal Reserve by reducing its overnight lending rate next Tuesday by another 0.5%. The Federal Reserve is expected to reduce the Fed Fund rate by 0.5% to 1.75% on April 30. What will happen to interest rates after these changes?

Fundamental influences

The Federal Reserve has been caught in a difficult position since last August. It had to battle against a virtual collapse in confidence in credit markets. In addition, it wanted to protect the U.S economy against inflationary pressures as well as defend the U.S. dollar.

The Fed chose to battle the confidence crisis in credit markets first. In so doing, it allowed the U.S. dollar index to fall 17% and watched while the inflation rate rose to 4.0%. The Fed Fund rate, at 2.25%, already is at a significant discount to the U.S. inflation rate and is generating negative returns after inflation throughout the U.S. yield curve.

Evidence of a recovery in confidence in credit markets appeared last week. Several U.S. banks announced substantial declines in quarterly earnings as well as major writedowns related to the credit crisis. Investors are guessing that the worst of the writedowns are over. Most stocks in the sector rallied on the news.

The Federal Reserve is expected to move to its next objectives after April 30. Inflation concerns and weakness in the U.S. dollar will be addressed. Traders will watch closely for guidance.

The best guess is that the Federal Reserve will halt reducing the Fed Fund rate at its April 30 meeting and will start to raise the Fed Fund rate as early as its June meeting.

Technical influences

Early technical signs of a recovery in long-term interest rates have appeared. An 11-month downtrend in U.S. 10-year treasury yields recently bottomed by establishing a range between 3.28% and 3.96%.

A tighter trading range between 3.28% and 3.62% evolved during the past month. Late last week, the tighter trading range was broken on the upside. In addition, yield moved above its 50-day moving average, and its 11-month downtrend was broken on the upside. The technical pattern on 10-year Government of Canada bond yields is similar. A breakout occurred last week when yield moved above 3.60%.

Seasonal influences

According to Thackray's 2007 Investor's Calendar, the yield on U.S. 10-year treasuries has a history of rising at this time of year. The period of strength is from April 16 to May 9. Yields have increased in 30 of the past 40 periods since 1967.

This annual event is tied to payment of U.S. taxes on or just before April 15. Taxpayers liquidate short-term money-market instruments and deposits to pay their taxes.

Brooke Thackray notes that, "after paying taxes, there is not a lot of money floating in the system, pushing up the price of money (raising interest rates), and pushing down the price of bonds."

Impact

A bottoming of long-term interest rates has important implications on a variety of markets including: the U.S. dollar (bullish); U.S. bond prices (bearish); financial service stocks (bullish as interest rate spreads widen); commodities (bearish). - Don Vialoux, chartered market technician, is the author of a free daily report on equity markets, sectors, commodities, equities and exchange-traded funds. Reports are available at www.timingthemarket.ca . Mr. Vialoux does not own U.S. or Canadian 10-year bonds mentioned in this report.

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