0.25% Key Interest Rate for the Next 14 Months.

The Bank of Canada (the Canadian central bank) announced on April 21, 2009 that it was lowering the "target for the overnight rate", being the interest rate at which major financial institutions borrow and lend one-day or overnight funds among themselves, to 0.25%. At the same time, the Bank Rate, being the minimum rate of interest that the Bank of Canada charges on one-day or overnight loans to financial institutions, was consequentially lowered to 0.50%. The target for the overnight rate is often referred to as the Bank of Canada's key interest or policy rate, as changes in the target for the overnight rate influence other interest rates, such as those for consumer loans and mortgages, and can affect the Canadian dollar exchange rate. This is a history making change, in that this is the lowest this rate has ever been.

In making this announcement, the Bank of Canada stated that 0.25% is what it judges to be the effective lower bound for overnight loans between financial institutions. In the past, the borrowing rate between financial institutions has operated in a 50 basis point band, with the Bank Rate as the upper end of this band and the target for the overnight rate being the midpoint of the band. As a result, before this change, the most creditworthy major financial institutions could have possibly obtained overnight funds at an interest rate less than the target for the overnight rate. Accordingly, absent other actions from the Bank of Canada, with this present lowering of the target for the overnight rate, the most creditworthy major financial institutions could have possibly obtained overnight funds at an interest rate below 0.25%, which could impair the functioning of credit markets in a low interest rate environment. However, the Bank of Canada has narrowed this operating band to 25 basis points through a few targeted methods, including by leaving the deposit rate, being the rate paid on deposits maintained by financial institutions with the Bank of Canada, unchanged at 0.25% per cent, and thereby providing the floor for the overnight rate.

Other changes announced by the Bank of Canada to assist in providing a floor for the overnight rate and a ceiling for the Bank Rate include making available an unprecedented daily cash settlement balance of $3 billion, far, far in excess of the usual $25 million daily cash settlement balance in the financial system. Other changes in this connection are set forth at this link: http://www.bankofcanada.ca/en/fixed-dates/2009/rate_210409_1.pdf.

Although this reduction in the target for the overnight rate and related assistance in reinforcing a 25 basis point operating band are of high importance in and of themselves, what is even more significant is the unprecedented guidance provided by the Bank of Canada regarding interest rates for the next 14 months. The Bank of Canada stated that, conditional on the outlook for inflation, the target for the overnight rate can be "expected to remain at its current level until the end of the second quarter of 2010 in order to achieve" the Bank of Canada's core inflation target of 1 to 3%. By way of background, the Bank of Canada's forecast is that Inflation is expected to fall through 2009, before gradually returning to the 2% mid range of the target in the third quarter of 2011.

In making this commitment, the Bank of Canada stated that "it is appropriate to provide more explicit guidance than is usual regarding [monetary policy's] future path so as to influence rates at longer maturities". The Bank of Canada has indicated that it will continue to provide such guidance in its scheduled interest rate announcements as long as the target for the overnight rate is at 0.25%. The next scheduled announcement date is June 4, 2009.

Bank of Canada Issues First Statements on Quantitative Easing

The Bank of Canada announced on April 23, 2009 in its April 2009 Monetary Policy Report, and Mark Carney, the Governor of the Bank of Canada, reiterated on April 28, 2009 in statements he made to the House of Commons Standing Committee on Finance, the outline of a framework that describes the Bank of Canada's monetary policy approach when the overnight interest rate is at its effective lower bound, being 0.25%. The Monetary Policy Report is available at this link: http://www.bankofcanada.ca/en/mpr/pdf/2009/mpr230409.pdf.

This newly announced monetary policy framework allows for the possibility that additional stimulus could be provided through the "unconventional" methods of quantitative easing and/or credit easing. Quantitative easing involves the creation of central bank reserves to purchase financial assets while credit easing includes outright purchases of private sector assets in certain credit markets that are important to the functioning of the financial system but that are temporarily impaired. Quantitative easing is effectively the electronic printing of money. Credit easing, on the other hand, does not need to be financed through the creation of central bank reserves and can, instead, be financed either by reducing holdings of other assets or by increasing government deposit liabilities.

In this connection, Mr. Carney stated that as "these are uncertain times, and if additional stimulus were to become necessary, the Bank retains considerable flexibility in the conduct of monetary policy at low interest rates." Mr. Carney stated that the framework was published because of the importance of outlining the available alternatives in a principled and transparent fashion. If the Bank of Canada were to deploy either quantitative easing or credit easing, Mr. Carney has stated that it would act in a deliberate and principled fashion.

Mr. Carney has made it clear that the focus of these alternatives, if implemented, would be to improve overall financial conditions in order to support demand and achieve the Bank of Canada's core inflation target. In this connection, asset purchases would be concentrated in maturity ranges that would have the maximum impact on the economy, actions would be taken in as broad and neutral a manner as possible and the Bank of Canada would act prudently, mitigating the risks to its balance sheet and managing its ultimate exit from such alternatives at a measured pace.

Will quantitative easing or credit easing be utilized? Given the Bank of Canada's and Mr. Carney's reported statements regarding the high level of confidence in the Bank of Canada's current policies, many commentators think that these alternatives likely won't be utilized absent some unforeseen economic shock.