Bank of Canada Preview

April 19, 2010

Tuesday’s interest rate statement at 09:00 EDT (13:00 GMT) will likely lay down the case for a Canadian rate hike as soon as June 1.  The last cyclical high in Canada’s overnight rate target was at 4.5%.  Such was cut by 25 bps in December 2007 and January 2008, then by 50 bps each in March and April of 2008.  A six-month pause followed when inflation climbed above the comfort zone.  Rate cutting resumed in October 2008 with a cut that month of 50 bps on the eight and another of 25 bps on the 21st.  Officials reduced the target by 75 bps in December 2008, 50 bps in January and March and a final time to 0.25% in April 2009, where such remains now.  In April 2009 after that last reduction, the authorities called 0.25% the “effective lower bound for the overnight interest rate and introduced a new policy with two elements.  The first was a promise not to let the rate get higher than 0.25% before 3Q10.  The second part of the new policy introduced an opt-out from the first part, making the 0.25% rate policy conditional on the bank’s subdued outlook for inflation.

Inflation adhered to the expectations of central bank officials until recently but now exceeds them. In a speech on March 25, Governor Carney underscored the conditional nature of the pledge on interest rates, and this reminder has rightfully generated speculation that the first rate increase will be moved up to June 1.  An increase this week is possible but considered unlikely.  Targeted core CPI rose from 1.5% last September to 2.0% in January and 2.1% in February, the latter being a half-percentage point higher than the forecast of 1.6% penciled in for 1Q10 in the last central bank full review of the economy.

The backdrop to the changed prognosis on Canadian rates is stronger than expected economic growth.  Bank forecasts are now undergoing their three-month check-up, and new estimates will be unveiled tomorrow.  Officials in January had projected GDP rises of 3.3% in 4Q09 followed by 3.5% in 1Q10.  However, GDP on an industry basis advanced 6.2% at an annualized rate during the five months between August and January, with increases of 20.7% in wholesale turnover, 13.5% in factory output, and 11.7% in construction.  Jobs increased 27.7K per month between October and March, a 2.0% annualized pace that was ten times more powerful than America’s 0.2% annualized rise over the same span.  Capacity utilization in Canada improved to 70.9% in 4Q09 from 68.7% in 3Q and 68.5% at the low in 2Q09.  Canada is again running a trade surplus.  Real exports rose 1.4% between January and February, and the nominal trade surplus of CAD 1.395 billion in February was the biggest surplus since November 2008 and produced a two-month average surplus of C$ 1.075 billion per month after CAD 189 million per month in the fourth quarter of 2009.  The Harper government presented a fiscal 2010/11 budget earlier this year that embodies significant spending cuts and would make Canada the first G-7 nation to erase its entire budget deficit.  The shortfall would be CAD 49.2 billion in FY10/11 but just CAD 1.8 billion within four years.

Canada has coped with very wide swings in its currency over the past eight years.  Against the U.S. dollar, such rose 78.6% from 1.6184 per USD in January 2002 to 0.9061 in November 2007, then retreated 30.6% to 1.3064 in March 2009 but appreciated 31.3% to a high of 0.9949 last week.  The return of risk aversion has depressed Canada’s currency to 1.0185/USD at present in spite of the plausibility of a signal tomorrow that rate tightening may commence at the following meeting on the first of June.  Whether the currency makes another immediate run at parity if that happens depends on the backdrop of global risk appetite and how explicitly the central bank signals a shift in stance.

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



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