Turmoil in global credit markets is hindering the Bank of Canada's efforts to reduce borrowing costs for individuals and companies.
In its latest assessment of the economy, the central bank warned that even if it continues to lower its benchmark rate, rates lenders charge on mortgages and loans may rise.
Commercial lenders are paying more to get credit themselves in markets that remain reluctant to share money, the Bank of Canada said in its Monetary Policy Report.
Since the credit crisis kicked off last summer, banks have recovered only about three-quarters of their increased borrowing costs by charging higher rates to their customers.
That's not likely to last, Governor Mark Carney said.
"We do expect that to ultimately be passed on ... unless their funding costs come down sharply," Mr. Carney said at a press conference.
The report reinforced economists' expectations that the bank will continue to lower rates to offset the impact of a deteriorating U.S. economy.
The central bank's acknowledgment that it can only do so much to keep borrowing costs low signifies a change in a relationship that many borrowers have come to take for granted over the past decade.
Most people assume that when the central bank cuts, their own variable-rate mortgages or commercial loans will fall by the same amount.
That relationship is breaking down because commercial banks can't access credit at the low rates available before the collapse of the U.S. subprime mortgage market last summer.
Many financial institutions were backing their loans with securities linked to those mortgages.
Those assets are now essentially worthless, leaving the banks that held them with weaker balance sheets and riskier bets to pay the yield on any bonds they issue to raise capital.
So even though the Bank of Canada has slashed its benchmark rate by 1.5 percentage points since December, the risk premium lenders are demanding is keeping the spread between the central bank's overnight target and other loans wider than under normal conditions.
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