Bank of Canada to Implement First Tightening Tuesday

May 31, 2010

Canada’s overnight money rate target has been at 0.25% since April 2009.  For the ensuing year, monetary officials also had made a contingent pledge not to raise the target before mid-2010.  Repo operations had also been undertaken to augment money market liquidity.  The end of those additional features of the accommodative credit policy ended six weeks ago and was communicated to investors through the last policy announcement and the subsequent Monetary Policy Report.

With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus.  The extent and timing will depend on the output for economic activity and inflation, and will be consistent with achieving the 2% inflation target.

More recent developments strengthen the case for a 25-basis point rate hike at 13:00 GMT tomorrow.

  • Economic growth last quarter of 6.1% at a seasonally adjusted annual rate (saar) even surpassed the central bank’s forecast.  Last month officials had revised their forecast to 5.8% saar from 3.5%.  Real GDP had expanded 4.9% saar in 4Q09.
  • Monthly GDP intensified in March when industrial production advanced 1.7% from February, and wholesale trade and retail sales increased by 2.0% and 1.8%.  Monthly GDP has expanded at a pace of 6.2% saar since October.
  • Jobs shot up 108.7K in April.  Scaled up to the larger-sized U.S. labor market, employment growth so far this year has run at an equivalent pace of 363K per month.
  • Although total CPI inflation between January and April was unchanged, on-year core inflation is now at 1.9%, marginally under target.
  • The Canadian dollar has weakened about 5% against the greenback since its late-April high, producing a significant easing of monetary conditions.  Foreigners divested Canadian securities in March for the first time since December 2008.  Merchandise imports rose 2.0% in April, while exports slid 0.7%.
  • The IVEY-PMI index averaged 58.25 in March-April, 6.9 points higher than in January-February.
  • Factory shipments and orders are 10.2% and 8.4% greater than a year ago.

Central bank officials expect Canada’s output gap, the measure of excess supply, to disappear sometime in the second quarter of 2011.  There are only nine meetings, including tomorrow’s, before the June 2011 policy announcement.  Actual GDP is expected to expand faster than potential supply-side GDP by 2.2 percentage points this year and by a further 1.2 percentage points in 2011.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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