The Canadian economy has been flashing warnings signs, and there is a good chance the country will slip into a recession this year. This could lead to further dramatic steps from the Bank of Canada to shore up the economy. While most analysts believe the Bank of Canada will reverse its interest rate policy, a growing number think it could introduce negative interest rates.
Canadian Economy Stumbles
The Canadian economy is heavily dependent on energy and commodities, with crude oil being one of the biggest contributors to the country’s gross domestic products (GDP). As a result, a weak global economy is undermining any chances for economic growth in Canada.
Since June 2014, oil prices have fallen roughly 75%. Oil prices faced further pressure in November 2014 when OPEC (Organization of the Petroleum Exporting Countries), announced that it would not reduce output; thereby, the market is flooded with a commodity for which there is little demand.
It didn’t take long for the effects of weak energy prices to impact the Canadian economy. The country slipped into a technical recession in the first half of 2015 after reporting a first-quarter GDP of -0.8% and a second quarter GDP of -0.5%1.
Bank of Canada Manipulates Interest Rates
To offset the economic instability of oil prices and help kick-start the Canadian economy, the Bank of Canada cut its key lending rate twice in 2015; once from 1.0% to 0.75%2 in January and then again to 0.5%3 in July. But that might not be enough.
In November, the most recent data available, the Canadian economy expanded just 0.3%, after zero growth in October and -0.5% in September.4 In 2016, the Canadian economy is projected to expand at an anaemic 1.50%.
To prop up Canada’s floundering economy the Bank of Canada may be forced to lower its key overnight lending rate even further. In the past, economists maintained that interest rates could never fall lower than zero, but that’s no longer the case.
Japan, the world’s third-largest economy introduced a negative interest rate on bank reserves of 0.1% in late January.5 The European Central Bank’s rate has been negative since 2014, and Denmark, Sweden, and Switzerland since a few years before that.
If low interest rates are supposed to encourage banks to lend money, negative rates punish banks for not lending.
Reverse and Negative Interest Rates and the Stock Market
Reversing interest rates means a country’s economy is simply not doing well and needs a boost. That’s not a great economic signal for the stock market, and this is playing out right now on the TSX.
The TSX is in bear market territory, down more than 20% since the highs of September 2014. Since the beginning of the year, the TSX has lost 5.0% of its value. While the Bank of Canada maintained its 0.5% overnight lending rate, the state of the economy suggests it will have to be more aggressive in the coming months.
But just how low will interest rates go? Reversing or even tipping into negative territory is supposed to encourage lending, but it also has the adverse effect of slamming investor confidence and the strength of the Loonie. Again, that’s not something the TSX can really absorb right now.
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- “Gross domestic product, income and expenditure, second quarter 2015,” Statistics Canada, September 1, 2015; https://www.statcan.gc.ca/daily-quotidien/150901/dq150901a-eng.htm.
- “Bank of Canada lowers overnight rate target to 3/4 per cent,” Bank of Canada, January 21, 2015; https://www.bankofcanada.ca/2015/01/fad-press-release-2015-01-21/.
- “Bank of Canada lowers overnight rate target to 1/2 per cent,” Bank of Canada, July 15, 2015; https://www.bankofcanada.ca/2015/07/fad-press-release-2015-07-15/.
- “Gross domestic product by industry, November 2015,” Statistics Canada, January 29, 2016; https://www.statcan.gc.ca/daily-quotidien/160129/dq160129a-eng.htm?HPA.
- McCurry, J., “Bank of Japan shocks markets by adopting negative interest rates,” The Guardian, January 29, 2016; https://www.theguardian.com/world/2016/jan/29/bank-of-japan-shocks-markets-by-adopting-negative-interest-rates.