Loonie sinks as Bank of Canada cuts borrowing costs again

The Canadian dollar dropped 1.38 cents US on Tuesday after the Bank of Canada moved to cut interest rates again, citing the global financial crisis and economic worries.

The loonie retreated in the wake of the cut, tumbling to close 82.39 cents US in afternoon trading on currency markets. The dollar has not closed that low since August 2005.

The central bank cut the target for the overnight rate — the rate Canadian banks charge each other for overnight loans — by one-quarter of a percentage point to 2.25 per cent and said that more cuts will likely be necessary.

"The weaker outlook for global demand will increase the drag on the Canadian economy coming from exports," the central bank said in a commentary. "Lower commodity prices will also dampen the outlook, working through a deterioration in Canada's terms of trade to moderate domestic demand growth. The marked tightening in Canadian credit conditions in recent weeks will restrain business and housing investment."

The bank expects average annual growth in real gross domestic product of only 0.6 per cent in both 2008 and 2009, before moving up to 3.4 per cent in 2010.

Easing inflation pressures also played into the latest rate cut. The bank said inflation likely peaked in the third quarter of this year and will fall below one per cent in the middle of 2009 before returning to its two per cent target by the end of 2010.

Canada's big banks, led by TD Canada Trust, did not begin lowering their prime rates until after 4 p.m. ET. Given the tightness in credit markets, the big banks have been reluctant to lower their lending rates.

Prior to the rate announcement, several economists had been pushing for a larger cut of one-half of a percentage point.

"Although the Bank [of Canada] decided to move in a smaller step than we expected today, with the U.S. economy in recession and other global trading partners slowing, the bank indicated that some additional easing may be necessary and we expect that it will cut the policy rate to two per cent before year-end to shore up Canada's domestic economy as the boost from the terms of trade weakens," said Dawn Desjardins, assistant chief economist at Royal Bank.

The central bank's next decision on rates is scheduled for Dec. 9.

Tuesday's rate cut followed a reduction of one-half of a percentage point on Oct. 8, when the Bank of Canada joined other world central banks in lowering borrowing costs in an attempt to stem the global financial crisis.