And the interest rate falls again

The Bank of Canada has cut its key interest rate (the overnight rate) to 0.25% which is the lowest the Bank has ever gone since its opening in 1935.  This move is the Bank’s respone to try to increase inflation to its desired 2% target.  It will be expected to stay at 0.25% for the next year until the economy begins to rebound and inflation increases back to its desired level of 2%.

Will the key interest rate go lower?  No.  This is the end of line for interest rate cuts.  0.25% is the middle bound for the overnight rate, which means the lower bound (the interest rate commerical banks can lend to the Bank of Canada at) is now 0% and the upper bound (the interest rate commercial banks can borrow from the Bank of Canada at) is now 0.5%.  Therefore, the only way to cut interest rates any lower would be through introducing negative interest rates.  Yikes.  Is that possible?  I doubt it but a top economist, Greg Mankiw, believes it’s an idea worth thinking about.

Inflation, which continues to fall, is expected to go negative before climbing back up.  By the third quarter of 2011, the Bank expects inflation to be back to the desired level of 2%.  This makes it look like the Bank is expecting a much slower recovery than it initially thought.  If we can only expect inflation to be back to 2% by 2011, it may seem Canada will not be operating at its full potential until around then as well.  So we may be looking at 2 more years of slow times.

If you are looking to buy a home, which I know my sister is, this could mean mortgages rates falling to even lower levels (the Big Banks in Canada have already started cutting rates slightly) .  With housing prices falling and low borrowing rates, home buying is looking lucrative as eventually housing prices will rise which makes buying today a great investment into the future.