As an oil exporter, Canada's economy is being hit hard by the over 50 percent plunge in oil prices since June and the Bank of Canada (BOC) lowered its 2015 forecast for growth and inflation, estimating that the fall in oil would reduce expected growth by 1.0 percent by the fourth quarter of 2015 and by 1.4 percent by the end of 2016.
The shock to Canada's economy from the plunge in oil prices is occurring against a backdrop of improving economic growth, but the BOC said investments in the oil sector - which accounts for 30 percent of the country's total business investment - will decline and domestic demand will suffer while inflation is already starting to reflect the fall in oil prices.
"The Bank's policy action is intended to provide insurance against these risks, support the sectoral adjustment needed to strengthen investment and growth, and bring the Canadian economy back to full capacity and inflation to target within the projection horizon," the BOC said.
The BOC cut its forecast for annual growth of Gross Domestic Product in the fourth quarter of 2015 to 1.9 percent from 2.4 percent in its previous forecast from October but raised the forecast for fourth quarter 2016 growth to 2.5 percent from 2.2 percent as the negative impact of lower oil prices is gradually mitigated by the stronger U.S. economy, a weaker Canadian dollar and the rate cut.
The forecast for consumer price inflation was lowered to 1.2 percent by the fourth quarter of 2015, down from October's forecast of 1.8 percent, while the forecast for the fourth quarter of 2016 was unchanged at 2.0 percent.
Canada's headline inflation rate eased to 2.0 percent in November from 2.4 percent in October while its GDP expanded by 0.7 percent in the third quarter of 2014 for annual growth of 2.59 percent, up form 2.54 percent.
Although the rate cut took economists and financial markets by surprise, analysts had already pushed back their expectations for a BOC rate rise to 2016 from mid-2015 and lowered their forecasts for the Canadian dollar due to the impact of lower oil prices.
The Bank of Canada issued the following statement: