Will Bank of Canada slash rates?

Remember when all the talk was when the Bank of Canada would resume its rate-hiking campaign? Such sweet and innocent days! Sheryl King, an economist at Bank of America, thinks that Europe’s worsening sovereign-debt crisis is going to push the central bank to cut its key rate – and cut it good.

“With the Eurozone sovereign debt and banking crisis showing no sign of containment, we think the Bank of Canada (BOC) will cut rates back to the effective lower bound of 25bps early next year from 1 per cent currently,” she said in a note. In other words, the bank will cut the key rate by an enormous 0.75 percentage points.

She now expects a so-called hard-landing in Europe, meaning that the economy is in deep trouble, and that will hurt the Canadian economy. Indeed, she thinks that economic growth in the first half of 2012 is going to flirt with outright contraction.

This is good news for government bonds. Ms. King believes that the yield on the 10-year Government of Canada bond will fall below 2 per cent as prices rise. (Bond yields and bond prices move in opposite directions.) Right now, it’s close to 2.1 per cent. The two-year bond should dip below 0.75 per cent, versus 0.9 per cent right now, she predicts.