Tuesday, April 22, 2008

Another rate cut: will the banks follow suit?

As expected, the Bank of Canada announced another interest rate cut this morning, taking the key interest rate from 3.50% to 3.00%.

The BoC cites a "deeper and more protracted economic slowdown in the U.S. economy", which is expected to continue to hit our exports. This rate cut is hardly a surprise, but there is some question as to whether the Canadian banks will balk at lowering their own prime lending rate. We've grown accustomed to seeing the banks adjust their own prime rate whenever the overnight rate changes, but the banks may be looking to change this expectation. Shrinking spreads on the borrowing business certainly make the banks less enthusiastic about lowering their prime rate, so I'm curious as to how they'll respond to this latest announcement.

Will borrowing rates drop by the full 0.50% to stay in lockstep with the BoC, or will they see a smaller drop, or even hold steady at their current 5.25% level? What will savings account rates do in the next couple of weeks? I think the most interesting thing to see will be the contrast between the two. If lending rates stay put, and deposit rates drop, then the banks will be in for some serious backlash.

As for the impact this change will have on the market, the TSX is down following the announcement, so at least things are staying interesting.

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