Big banks may not follow Bank of Canada if central bank cuts rate

Interest-rate cut would be an effort to jumpstart the economy by making it cheaper for consumers and companies to borrow money

BoC Policy Report 20150121

OTTAWA – Canada’s big banks may resist the urge to pass on to borrowers the full benefit if the Bank of Canada decides to reduce its key interest rate on Wednesday, a reluctance that could anger borrowers.

CIBC analyst Robert Sedran suggested a 25-basis-point cut in the central bank’s overnight rate could be followed by only a 10-basis-point reduction in the prime rate by the big banks.

“Either way, we would not expect an overnight rate cut to be met with a full reduction in bank prime rates,” Sedran wrote in a report Tuesday on the eve of the Bank of Canada announcement that is hotly anticipated this time around amid concerns the economy is in a recession.

If the Bank of Canada cuts interest rates, it will be an effort to jumpstart the economy by making it cheaper for consumers and companies to borrow money.

But a cut by the central bank won’t automatically trigger a similar cut in the prime rate at the country’s big banks. That rate is currently standing at 2.85 per cent.

Moves in the prime rate affect variable rate mortgages as well as home equity lines of credit and other variable-rate forms of borrowing.

When the Bank of Canada unexpectedly cut the rate in January by a quarter of a percentage point, the big banks cut their prime rates by 0.15 — but only after a week of hand-wringing about what to do.

Mortgage broker Frank Napolitano said if the banks don’t pass on the full amount in the event that the Bank of Canada once again opts to cut its key interest rate, they will face the wrath of angry borrowers.

“With the pressure that was put on them in January, they have to give back the quarter point, they have to follow suit,” said Napolitano, managing partner at Mortgage Brokers Ottawa.

“I don’t know that there is going to be as much leniency this time around from consumers.”

Sedran noted the banks are trying to protect their margins by not passing on the full cut to their customers.

“A partial move would protect the sector’s current level of profitability, which is not the same as saying that the banks are taking advantage to protect a benefit they now have,” he said.

The central bank is expected to cut its outlook for economic growth this year from its April forecast of 1.9 per cent. But investors and economists are split on what the central bank has in store for its key interest rate.

The C.D. Howe’s monetary policy council recommended the Bank of Canada keep rates on hold, but the think-tank’s group of economists was not unanimous, with four of the 11 voting for a rate cut.

When the central bank cut the rate in January, it explained it was buying “insurance” for the economy in the face of falling oil prices.

The damage done by the drop in oil has been more punishing than many expected, and the economy contracted in each of the first four months of the year. That’s spurred speculation that the country may have slipped into recession in the first half of the year.

However, most economists predict the economy will rebound in the second half the year, adding clout to arguments that the Bank of Canada should keep rates on hold.

“A dovish bias has merit, but it is likely premature to give up on the rebound story and court the substantial risks associated with further rate cuts,” Scotiabank economist Derek Holt wrote.

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