OTTAWA — The Bank of Canada made a bet Tuesday that, if interest rates were virtually zero, businesses might be more inclined to borrow to build new factories, buy new equipment, and put unemployed Canadians back to work.

The central bank lowered its key overnight rate Tuesday to 0.5 per cent — a record low — and many observers say the bank could even take the rate as low as it could go, to zero, in all all-out effort to make it cheaper and easier for commercial banks to lend money and spur economic growth.

Several commercial banks did lower some of their interest rates within hours of central bank’s announcement.

But the new, lower rates are unlikely, by themselves, to get the economy moving again.

“You can have the cheapest money in the world, but if people keep reading about the layoffs and falling housing prices, that takes away confidence and makes people much more cautious about borrowing, and leaves all the stimulus that you’re trying to put in place basically on the sidelines,” said Warren Jestin, chief economist at The Bank of Nova Scotia.

Consumers tend not to respond to incremental changes in interest rates, in any event, and while business borrowers sometimes respond to those small changes, many businesses right now are worried about their ability to pay any loan, regardless of the terms.

“In a recession, entrepreneurs tend to stay a bit on the sidelines when it comes to developing a new project, putting up a new plant, buying new equipment. They generally want to wait,” said Jean-Rene Halde, the CEO of Business Development Canada, the federal Crown corporation responsible for making loans to businesses.

“So, in a recession, we see (fewer) projects being started. It’s one of the reasons we have a recession,” Halde said.

As far as consumers go, changes in the overnight rate charged by the Bank of Canada is not their biggest motivation. Certainly, interest rates that stay low over time make things such as homes and cars more affordable. But economists say a quarter-point here or a quarter-point there from the Bank of Canada will have a negligible effect on consumer behavior.

Indeed, consumers in Canada have been happily enjoying interest rates that are at low levels not seen in a generation. The number of mortgages taken out by Canadians as of December was 10.7 per higher than in the same month last year. Overall consumer credit, which would include mortgages, credit cards, and car loans, was up 9.1 per cent to about $416.2 billion at the end of December. By contrast, consumer credit in the U.S. has been shrinking.

The biggest motivating factor for consumer borrowing is job security. When consumers are confident they’ll have a regular paycheque, they’re more likely to sign up for those monthly payments on everything from new TVs to new homes.

Jestin says that, with recent job losses — nearly 250,000 Canadians lost their jobs between November and January — consumer demand for credit is almost certain to weaken, no matter the interest rate.

As for business borrowers, the Bank of Canada is hoping the cost of borrowing will be seen as too good for even the most conservative business manager to pass up — and those business managers will respond by borrowing for new investment to create new jobs.

But even that assumption is flawed, said Jestin. “You knock off 50 basis points at these levels, and it’s not likely to have a big effect. We’ve gotten to levels now that are so extraordinarily low that the degree of further impetus in the economy is extraordinarily limited.”

Furthermore, savvy business managers know that low interest rates will be here for a while, which means there’s no rush to start up a new project until they can be sure of firming market conditions.

“That’s the confidence problem,” Halde said. “(Businesses say) I have a great project, but maybe I should wait three months or six months before starting it. They may say, at this price, it’s time get going. And that’s obviously the hope.”

Bankers such as Halde say most of the lending they’re doing nowadays is to shore up existing projects.

But can the Bank of Canada do better than zero and make the cost of borrowing too good to pass up? It can, by using what it described Tuesday as “non-traditional” ways of lowering the costs commercial banks pay to get more money, which they, in turn, lend out to businesses and consumers. The Bank of Canada could, for example, start buying up assets, such as Government of Canada bonds, held by Canadian banks. If the Bank of Canada did this, it would essentially be pumping more cash into the system — and cash, as any good, responds to the forces of supply and demand. When there is more cash available, it tends to be cheaper to borrow it.

BREAKING NEWS FROM THE GLOBE AND MAIL

KEVIN CARMICHAEL

Tuesday, July 15, 2008

OTTAWA — The Bank of Canada left its benchmark interest rate at 3 per cent and predicted raging oil and food prices would cause inflation to surge past 4 per cent by early next year.

Governor Mark Carney and his five deputies on the governing council also cut their estimate for economic growth for 2008 to 1 per cent, which would be the weakest in almost two decades, citing “protracted weakness” in the U.S. economy and “ongoing turbulence” in financial markets.

The central bank’s decision to leave borrowing costs unchanged suggests Mr. Carney’s biggest concern is keeping a lid on Canadians’ expectations about prices. Policy makers raise and lower interest rates to keep inflation advancing at an annual rate of 2 per cent and are uncomfortable with prices advancing any faster than 3 per cent.

“Commodity prices are continuing to outstrip earlier expectations,” the Bank of Canada said in its statement today in Ottawa. “This has led to further increases in Canada’s terms of trade and real national income, and has altered the outlook for global and domestic inflation.”

There was little immediate reaction in financial markets as most investors and economists were expecting the Bank of Canada to leave interest rates unchanged. In the flurry of research notes that followed the central bank’s decision, economists said Mr. Carney is handcuffed by weaker growth and bubbling inflation, leaving him little choice but to stand pat.

“Overall inflation is growing concern for the Bank of Canada, but the bank’s growth worries will keep a hold on rates for the time being,” said Meny Grauman, an economist a CIBC World Markets in Toronto.

Win Thin, a currency strategist at Brown Brothers Harriman & Co. in New York, said the futures market for Overnights Index Swaps, where values are based on the underlying interest rate, suggests investors expect the Bank of Canada to lift borrowing costs by no more than a quarter point over the next 12 months, compared with expectations of a three-quarter point increase as recently as mid-June.

In its statement, the central bank called the risks to its outlook “balanced.”

The Bank of Canada also left its benchmark interest rate – the target it sets for overnight loans between banks – unchanged at 3 per cent at its last policy meeting in June, a move that surprised market players.

Before that announcement five weeks ago, policy makers had slashed their key rate by 1½ points over four decisions dating back to December, a campaign aimed at offsetting slumping U.S. demand for exports and the global credit crunch.

The priority now is persuading Canadian business owners and workers that their central bank will keep inflation from burning out of control.

One of the biggest worries at the central bank is that companies will start charging higher prices to compensate for higher commodity prices and workers will demand higher wages, sparking an inflation spiral.

There is some evidence this might already be happening. The central bank’s July survey of businesses showed 36 per cent of the companies expected inflation will climb above 3 per cent, compared with 17 per cent in April.

Policy makers stressed in their statement today that total inflation’s burst to 4 per cent in the first quarter of 2009 will be temporary. They predicted energy prices will stabilize, allowing inflation to ease back to 2 per cent by the second half of next year.

Canada’s economy hasn’t grown slower than 1 per cent since it advanced 0.9 per cent in 1992, one year after a recession, according to International Monetary Fund data.

Still, the central bank said little has happened to change its longer term growth outlook. Higher prices for exports, relatively low interest rates and a “gradual recovery” in the U.S. will spark a Canadian rebound starting early next year, the Bank of Canada said.

The central bank shaved its growth estimate for 2009 to 2.3 per cent from 2.4 per cent and left its projection for 2010 unchanged at 3.3 per cent.

The Bank of Canada will expand on its current thinking on the economy when it releases an updated policy report on Thursday. The central bank next meets to consider its benchmark interest rate on Sept. 3.

The Canadian Press

July 10, 2008 at 4:04 PM EDT

OTTAWA — The Bank of Canada should move to head off inflation in the country by raising interest rates next week for the first time in a year, says a consensus view by a deeply divided panel of nine economists associated with the C.D. Howe Institute.

A closer look suggests the economic think tank’s monetary policy council was almost evenly divided 5-4 between those favouring a rate increase and those who thought the central bank should leave the rate unchanged.

Four members were in favour of the central bank leaving its overnight interest rate unchanged at 3.0 per cent next Tuesday, four others advocated a quarter-point increase and one wanted a half-point increase.

The overnight rate is a benchmark that is used by commercial banks when they set various other lending rates, including for shorter-term mortgages.

“Notwithstanding the division in opinion regarding the Bank of Canada’s July 15 decision, the main theme of the group’s discussion was concern about rising inflation and rising inflation expectations,” the institute said in a release.

“Several members argued that the Bank of Canada should act aggressively to prevent expectations of higher inflation becoming more pronounced and affecting price and wage setting.”

The economists cited high oil prices, the increased likelihood inflation will move above the upper end of the bank’s target range of one to three per cent, rising wages and a recent Bank of Canada business survey that found 42 per cent of firms planned to increase prices for their products.

The private-sector think thank said economists who favoured no action said they were concerned about the slumping economy, but even in this group, most saw the rate going to at least 3.25 per cent in the next six to 12 months.

The Bank of Canada uses monetary policy to keep inflation in check. Raising rates increases borrowing costs, thereby slowing down economic activity and growth.

The central bank began trimming the overnight rate from the then 4.5 per cent level in December as the economy began showing signs of slowing and perhaps contracting.

But after slicing 150 basis point from the overnight rate, following the lead of the United States, the Bank of Canada halted its easing policy last month, saying that inflation was beginning to re-emerge in Canada.

The bank last raised the overnight rate in July 2007.