The Bank of Canada will lower rates again this month, predict economists with TD Securities, although they suggest that the side effects that rock-bottom rates may bring aren’t worth the incremental stimulus.

The firm is forecasting that the central bank will reduce rates by another 25 basis points this month. However, it warns, “Ultra-low central bank rates are not without their perils.”

“In making this claim, we refer not to the risk of excessively stimulating the economy, but rather to the undesirable complications that arise when central bank rates become quite low,” it says.

TD says that the economic fundamentals justify lower rates, even negative rates if that was possible. But it cautions that taking rates lower brings “several important complications” that means further easing may not be appropriate. “These headaches may be sufficiently large so as to undermine the pittance of further stimulus the economy would receive by cutting another 25-50 basis points, especially given the reality that the majority of Canadian economic woes are related to the U.S. slowdown and falling commodity prices, neither of which can be healed by domestic monetary policy,” it suggests.

The problems it foresees include operational, and profitability, issues for money market funds; similarly, it would pose problems for a variety of banking products; and, it could mean no return for commercial banks that lend excess reserves to the central bank; among other things.

TD says that all of these problems are surmountable. “Borrowing rates can cease to respond to central bank easing so as to allow banks to maintain a viable profit margin; money market funds can survive by cutting their expense ratios and possibly operate at a loss, or by scaling back in their operations with the result that short-term bond yields could push upwards; and the rules governing the rate at which commercial banks lend their excess reserves to the central bank could be adjusted.”

“But is it really worthwhile for a country like Canada to pull out all the stops and to cut a further measly 25-50 basis points on top of the formidable 400 basis points that has already been delivered?” TD asks.

“Every central bank should think twice about whether squeezing that last ounce of stimulus into the economy makes sense in the broader context. We suspect the macroeconomic benefit of cutting the overnight rate further is overshadowed by the hornet’s nest of issues that will be stirred up by doing so,” it says.

“What’s more, the problematic implications specific to the banking sector may take on a particular poignancy for a country like Canada that has defined itself throughout this crisis as a nation with a strong and resilient banking sector,” it concludes. “The Canadian case is further nuanced by the fact that a great deal of domestic stimulus bleeds across the border in the form of imports from abroad, while Canada’s big export and resource sectors are essentially reliant upon the rest of the world to get back on track, and not so much on the adroit actions of domestic central bankers.”

IE