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Traders signal deeper cuts after Bank of Canada's interest rate shocker

Bond traders reeling from the Bank of Canada’s shock interest-rate cut are betting Governor Stephen Poloz will do it again.

Yields on two-year government bonds are lower than those on six-month bills for the first time in almost two years, suggesting another cut after the central bank’s surprise move to reduce the rate on overnight loans by a quarter-percentage point to 0.75 percent on Jan. 21. Poloz called it insurance for an economy buffeted by the oil rout and deflationary pressures.

“In the front end of the curve, the major driver is central-bank monetary policy expectations, and this shows you the market is pricing in more easing,” Andrew Kelvin, senior fixed-income strategist at Toronto-Dominion Bank, said by phone from Toronto. TD is forecasting a further 0.25 percentage point reduction at the Bank of Canada’s March 4 meeting. “We think they’re likely to ease again in March.”

Two-year bonds are yielding 0.54 percent, five basis points less than six-month bills at 0.59 percent, implying slower economic growth. The longer-term securities last yielded less in May 2013.

Canada became the first Group of Seven nation last week to loosen monetary policy in response to the plunge in oil prices, saying the slump will weigh on everything from inflation to business spending. The bank downgraded its growth forecast to a 1.5 percent annualized pace, from an October estimate of 2.4 percent, following the drop that has taken crude, the country’s biggest export, down more than 50 percent since June. The commodity traded at $45.59 a barrel Jan. 23 in New York.

‘DOWNSIDE RISKS’

“We see further weakness in oil prices in the first half,” Kelvin said. “The fact they cut without much warning in January shows they want to be proactive about it, and that tilts the likelihood toward March.”

The oil shock “increases both downside risks to the inflation profile and financial-stability risks,” the Bank of Canada said in its report last week. The cut is “intended to provide insurance against these risks.”

Poloz said at a press conference the central bank would take out more insurance if economic conditions warrant. The BOC is assuming oil prices at about $60 per barrel, the average for Brent since early December. If they persist around $50, first- half growth could fall to 1.25 percent, the bank said.

A cut of 25 basis points “ain’t going to do that much for the economy,” David Madani, an economist at Capital Economics in Toronto, said by phone Jan. 23. “Clearly, the bank is spooked by the collapse in oil prices. If it really is concerned, there’s a really strong likelihood they’ll cut rates further.”

WIDE OPEN

Madani, the only forecaster in a Bloomberg survey conducted from Jan. 9 to Jan. 14 who said lower rates were in store, said the gap in the actual price of oil and the bank’s assumptions leaves the door wide open for another rate cut. He’s estimating it will come in April.

Doug Porter, chief economist at the Bank of Montreal, said he’s anticipating a rate cut as soon as March 4, the next time the Bank of Canada meets.

“The case for a second insurance move looks supported by oil prices merely moving sideways, let alone falling further,” Porter said in a note to clients last week.

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