ECONOMIC AND FINANCIAL MARKET UPDATE
October 8, 2008
Rate cut by major central banks
The Federal Reserve, Bank of England, Bank of Canada, ECB, Riksbank and Swiss National Bank all cut policy rates by 50 basis
points in an unprecedented co-ordinated move on October 8. Heightened financial market stress that weighed on equity markets and
saw LIBOR rates, a proxy for funding costs, spurt higher prompted policymakers to act in an effort to resurrect investor confidence
and shore up the financial system. The numerous actions to-date by governments and central banks across the globe have elicited little
joy but, given the magnitude and persistence of these interventions, we expect they will begin to ease strains in financial markets.
Downside risks present but domestic demand strong enough to keep Canada's economy out of recession
The Bank of Canada has lowered the policy rate to 2.50% in a co-ordinated rate move to ward off further deterioration in financial markets and stave off a recession in Canada.
Our view is that the aggressive policy actions taken by global central banks and governments will get traction, easing some of the stress in financial markets and that Canada's domestic economy, while slowing, will keep the economy from falling into recession.
Canada's two-speed economy is likely to persist, with the trade side restraining the overall pace of growth, while the domestic side stays firm and keeps the economy off a recessionary path.
On balance, the economy is likely to grow at a mild 1% on average in the final quarter of 2008 and early 2009, a favourable result compared to declining growth in the United States, but still well below the economy's potential pace.
We, therefore, expect the Bank of Canada to hold the policy rate at 2.5% but acknowledge the risk of additional easing if credit markets do not respond positively.
Economic data point to a U.S. recession
Recessionary conditions exist in the U.S. economy with the high cost of capital curtailing business and consumer spending, resulting in negative economic growth rates in second half of 2008 and early next year.
We expect the passage of the government's rescue plan to eventually result in the stabilization of funding markets and an easing in the cost of capital. However, this process will take time and is unlikely to prevent the economy from tipping into recession.
To address the deteriorating economic outlook, we expect the Fed to cut the Fed funds rate by an additional 50 basis points to a cyclical low of 1% by year-end.
Despite the bleak near-term outlook, we look for the U.S. economy to recover in late 2009 as the easing in the cost of capital and credit conditions reinvigorates business investment and the end of the housing market recession takes some pressure off household balance sheets.
The Fed is likely to hold the funds target at the expected near-term trough of 1.00% until policymakers are assured that the economy is on firmer ground.
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