Morgan Stanley: Canada has 1 in 3 chance of interest rate cut in 2015

A major U.S. investment bank says there's little chance that the Bank of Canada hikes interest rates in the next two or three years, and says there's a one in three chance of a rate cut by the end of the year.

Morgan Stanley said in a report Friday that the sudden plunge in oil prices has changed the outlook for Canada's economy. While most watchers had been expecting an eventual, gentle hike in interest rates to start in 2014 or 2015 at the latest, that hasn't happened — so far, at least.

Now, the bank says it expects any rate hikes to come far off in the distance, maybe some time in 2017 at the earliest. "We do not expect the first rate hike from the Bank of Canada until 2017," the bank said. "It will not raise rates unless inflation picks up."

The Bank of Canada is next due to meet at the end of this month to discuss interest rates. For the last 34 consecutive meetings, dating back to September of 2010, the bank has opted to stand pat and keep its benchmark rate at one per cent.

But given the impact of lower oil prices on the overall economy and inflation, the bank says there is "a subjective probability of 1 in 3 that the Bank of Canada cuts interest rates in 2015."

Morgan Stanley also downgraded its expectations for Canada's economy this year and next. The bank thinks the Canadian economy will expand by 1.8 per cent this year, slowing to1.5 per cent next year. Both forecasts are a full percentage point lower than their previous forecast — and both are lower than the Bank of Canada's forecasts, which call for 2.5 per cent growth this year and 2.3 per cent in 2016. (It's worth noting that the central bank's previous projections have turned out to be slightly pessimistic since the recession.)

Loonie headed to 80 cents?

There's a broad consensus among economists that while some sectors could be poised for growth because of cheap oil — Ontario and its loonie-dependent manufacturing industry is often singled out — on the whole, cheap oil will be a net liability, Morgan Stanley and others are saying.

Even the central bank has been ratcheting down its expectations of late. Just this week, the bank's deputy governor Timothy Lane said "lower oil prices are likely, on the whole, to be bad for Canada."

Morgan Stanley's gloomy outlook extends to the loonie, too. The bank says "we think USD/CAD at 1.25 is a reasonable target in coming months." That means the bank is expecting $1 US to be able to buy $1.25 Canadian soon — which means the loonie could drop to as low as 80 cents US some time this year, according to Morgan Stanley.

"If the market prices in a higher chance of rate cuts in Canada,as we expect it will, [the loonie] will come under further pressure," Morgan Stanley said.