The Bank of Canada has announced (bolding added):

lowers overnight rate target by 1/4 percentage point to 1/4 per cent and, conditional on the inflation outlook, commits to hold current policy rate until the end of the second quarter of 2010

OTTAWA – The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of a percentage point to 1/4 per cent, which the Bank judges to be the effective lower bound for that rate. The Bank Rate is correspondingly lowered to 1/2 per cent. The deposit rate – the rate paid on deposits held by financial institutions at the Bank of Canada – is left unchanged at 1/4 per cent and provides the floor for the overnight rate. Details of the Bank’s operating framework at the effective lower bound can be found here.…

The Bank expects core inflation to diminish through 2009, gradually returning to the 2 per cent target in the third quarter of 2011 as aggregate supply and demand return to balance. Total CPI inflation is expected to trough at -0.8 per cent in the third quarter of 2009 and return to target in the third quarter of 2011. While the underlying macroeconomic risks to the projection are roughly balanced, the Bank judges that, as a consequence of operating at the effective lower bound, the overall risks to its inflation projection are tilted slightly to the downside.With monetary policy now operating at the effective lower bound for the overnight policy rate, it is appropriate to provide more explicit guidance than is usual regarding its future path so as to influence rates at longer maturities.

Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target.The Bank will continue to provide such guidance in its scheduled interest rate announcements as long as the overnight rate is at the effective lower bound.

I am flabbergasted at the bolding. I certainly can’t remember seeing anything quite so explicit before, although I’m sure some professional Central Bank watchers will be able to supply other examples. There are certainly implications for the relative pricing of FixedFloaters and their paired Ratchets in this announcement!

Canada Prime followed the overnight rate fairly swiftly:

- BMO cut 25bp to 2.25%
- RBC cut 25bp to 2.25%
- NA – no announcement yet
- TD cut 25bp to 2.25%
- CIBC cut 25bp to 2.25%
- BNS cut 25bp to 2.25%

I’ve been watching fixed-floaters for a while and the floaters seem to anticipate close to zero (or negative) dividends. Look at BCE.PR.E (float) / F (fixed) which interconvert next February (9.5 months). The Fixed iprice is $1.50 more ($15.08 vs $13.50 ask) with only 0.63 more in annual dividend (0.45 in 9.5 months if prime is constant) until Feb 10/2010 when they have to be the same price. The expected dividend on Pr.E for the same yield to a common price is minus 23 cents annually.

I figure that the floater yields 20% annualized until the exchange date, assuming it rises to the fixed price (12.5% more yield than the fixed pref). If the floater had zero yield, the difference would still be a 8.3% higher yield to the floater. The real issue is that low 5-year GOC yields mean the fixed prefs will have an even lower dividend at reset (now $1.10, then ???) so may fall in price. Oddly then, despite the amazing declines in prime, the floaters look like a better deal in this pair.

Another example is the famous BBD.PR.B(float)/D(fixed) pair. Although their exchange date is 3.5 years away, the D trades at $5.50 more than the B. If, over those 3.5 years, the price of B rises to the price of D, the B yield will be 20% annually — not bad for a floater and 11% over the D. This is a great arbitrage trade as long B short D can return the 11% with no credit risk, even if one has to wait 3.5 years (6% if the floater yield goes to zero). The B pref needs to rise 38% to make sense vs the D pref.

These are the two most egregiously mismatched pairs I know about right now, and with them I would say, don’t cry for the floating rate pref investor at these prices!