Bank of Canada delivers shock rate cut as ECB gears up for quantitative easing

OTTAWA/FRANKFURT (Reuters) - The Bank of Canada joined the list of "unpredictable" central banks on Wednesday with a shock quarter point rate cut as the European Central Bank prepared a 600 billion euro ($695 billion) bond-buying program aimed at lifting Europe out of its economic doldrums.

The Canadian move came in response to a sharp drop in oil prices that hit the commodity-dependent economy, expected to grow by just 1.5 percent in the first half of this year compared with the central bank's previous forecast of 2.4 percent.

The surprise move follows Denmark's rate cut this week and a shock Jan. 15 decision by the Swiss National Bank to drop its cap on the Swiss currency against the euro and cut its rates further, likely in anticipation of the ECB's money printing plan, which appears set to weaken the euro.

Rising deflationary risks also seem to be registering at the Bank of England where two policymakers on Wednesday ditched their long-standing calls for an end to record-low interest rates.

The U.S. Federal Reserve, which appears committed to a rate rise this year, meets next Tuesday and Wednesday, although it is not expected to act until June of this year, at the earliest.

The global economy outside of the United States has turned distinctly gloomy, with Japan and Europe struggling to gain traction. A slump in oil prices to below $50 a barrel has added to deflationary concerns and to worries that the global economy is struggling with a widespread deficit in growth.

"We think in light of recent developments, it is clear that QE is coming, and knowing (ECB President Mario) Draghi’s knowledge of markets, it is unlikely he will disappoint – either by holding off on QE or announcing a smaller-sized program,"

Vasileios Gkionakis, head of global foreign exchange strategy at UniCredit Bank in London said in a report.

Central bankers from Turkey to China have weighed in with rate cuts recently as the global economic outlook has dimmed. That has raised the stakes for the world's "big three" central banks of the Fed, Bank of Japan and the ECB and made policy decisions more tricky and potentially more risky.

The Federal Reserve is the sole major central bank that may be juggling with a near term rate hike, especially as skepticism grows at the Bank of England and the ECB is heading the opposite way.

"The ECB has a huge task this week to restore confidence and trust in financial markets," said Jaisal Pastakia, investment manager at Heartwood Investment Management. "The ECB’s record has been commendable ... but the stakes are getting higher."

With the likely start date for the ECB bond buying program imminent and only one other opportunity at the beginning of March for governors to agree details, pressure will be high on them to finalize talks and announce the mechanics on Thursday.

Central bankers need to decide how far the ECB goes in meeting demands from Germany's Bundesbank for the risk of the scheme to rest with national central banks in countries from Greece to Italy, rather than with the ECB. ECB President Mario Draghi will speak to the media at 1330 GMT on Thursday.

The duration of the program is highly significant but also contested because Germany is troubled by the concept of bond-buying, particularly any government bond purchases, and wants to limit its scale.

SLOWING CHINA ADDS TO GLOBAL WOES

China and the United States are the only major economies growing at a meaningful rate yet Beijing has also signaled concerns over growth with more than $8 billion of injections of short term loans into the banking system on Wednesday.

The move followed data on Tuesday that showed the world's second-largest economy grew 7.4 percent last year, the weakest rate since China was hit by sanctions in 1990 after the Tiananmen Square crackdown.

China cut rates on Nov. 24 for the first time in two years due to slower factory growth and a stalling property market, although People's Bank of China chief Zhou Xiaochuan on Wednesday sought to downplay economic risks.

"Generally, if the average indicator of the Chinese economy is OK, the way for the central bank to have a specific policy targeted to the real estate market is difficult," he told the World Economic Forum in Davos, Switzerland.

That leaves the Fed on its own with its plans to lift rates above zero for the first time in six years despite the potential for a huge undershoot in the bank's inflation target.

"There is no need to rush to raise rates; at the same time we want to make sure that we appropriately act in a way that we don’t get behind the curve," San Francisco Federal Reserve Bank President John Williams told reporters on Friday.

The U.S. economy added 1.7 million jobs in 2014 alone and likely expanded by 2.6 percent in the year.

While it will be hit by falling global demand, U.S. imports and exports of goods account for less than a quarter of gross domestic product, compared with China's near 50 percent, meaning it is more insulated from the global economy due to the huge size of its domestic market.

(Additional reporting by Leah Schnurr in Ottawa, Paul Carrel in Frankfurt, Koh Gui Qing and Judy Hua in Beijing, Paul Taylor in Davos, Mike Dolan, David Milliken and Li-mei Hoang in London; Writing by David Chance; Editing by Tomasz Janowski)

By Randall Palmer and John O'Donnell