Bank of Canada Cuts Overnight Rates

Courtesy of Sandra Boyd, Posted 21 Jan 2015

The Bank of Canada announced last night that they will cut the target overnight rate (the interest rate at which major financial institutions borrow and lend one-day, or "overnight", funds among themselves) by 25 basis points (0.25%) from 1.00% to 0.75%.

Economists on Bay Street certainly did not expect a cut and many even expected a hike later this year. Thus, there is a huge reaction in the markets today. The Canadian Dollar is down 1.25 cents to a 6 year low of 0.813, and the 10-year Canada bond yield is below 1.5%.

The bank said the main reason to cut is "in response to the recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada." Since Canada practices inflation targeting, threats to the inflation outlook justify this rate cut. Bank of Canada believes there is "considerable uncertainty" regarding how low oil prices will affect Canada. As a result, it decided to cut rates to provide "insurance against these risks"

Implications Based on Historical Observations

Based on what happen in 2012 when the US 10-year treasury yield fell near 1.4%, it is likely that investors would search for yield again. This would be positive for high yield funds and dividend/income funds: ‎"Low volatility" funds tend to pay a higher dividend, which is good in a low interest rate environment. 

To view the Bank of Canada's press release click here.