Canadian monetary Policy On Hold

July 9, 2008

Stagflation is an issue in Canada, too, despite on-year core CPI of 1.5% in four of the last six reported months including May and headline inflation of 2.2%.  May saw total consumer prices jump 1.0% because of a 5.5% advance in energy.  The CPI on a seasonally adjusted basis advanced 3.2% at an annualized rate in the six months to May. Canadian producer prices rose 0.6% m/m and 2.4% y/y in May, and raw material prices soared that month by 3.1% m/m and 27.1% y/y.  Most importantly, the Bank of Canada’s quarterly business survey in 2Q08 found 36% of people anticipating CPI inflation to exceed 3% over the next two years with another 50% looking for inflation to surpass the 2.0% target.  Three months ago and six months ago, just 17% and 12% predicted more than a 3% rate of inflation.  The Holy Grail of central banking, well-anchored price expectations, has become less assured in Canada.  Canadian monetary officials will not risk a rate cut in this environment, and since Fed policy is also on hold, a wait-and-see stance poses less upside risk to the Canadian dollar.

Economic growth hit a very soft patch after last summer.  As a result of GDP growth of 0.8% in 4Q07 followed by -0.3% in 1Q08, the on-year rate of economic expansion fell to a sub-trend 1.7% from 3.1%.  Between December 4th and April 22nd, the Bank of Canada implemented four easings that slashed the overnight money target by 33% to 3.0% from 4.5%, and economic prospects are looking less worrisome.  Corporate investment plans have been revised up, and both building permits, which hit a 7-month high in May, and housing starts, which recorded a similar average level in 2Q08 to the level in 4Q07, show some resilience.  The IVEY-PMI score of 69.6 in June was at a 37-month high, and real GDP grew 0.4% in April, a good start to the spring quarter.  However, consumer confidence keeps sinking, dropping to 79.6 in June from 85.8 in May, and non-energy exports in April edged up just 0.2% and remained 10.2% below their year-earlier level.

Next Tuesday, July 15th at 13:00 GMT, officials at the Bank of Canada, who surprised market observers on June 10th when they did not cut rates, will announce that the overnight target is again being held steady.  Two days later, they will release an interim analysis updating their semi-annual monetary policy report from last April.  In the April report, they had projected CPI inflation of 1.9% in 2H08 but revised such last month to over 3%.  Officials in April  had expected growth in 1Q08 to be 1.0% saar, not -0.3%, and had projected growth of 0.3% saar in 2Q08 and 1.8% saar in 2H08.



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