Bank of Canada Interest Rate Preview

July 19, 2010

The fifth out of eight scheduled interest rate decisions in 2010 will be unveiled at 13:00 GMT Tuesday.  Analysts will be combing tomorrow’s statement for clues to whether more tightening is coming in the near term.  There’s little doubt that tomorrow will see a second increase to 0.75%, which will put the Bank of Canada two moves ahead of all the other G-7 central banks.  After the first on June 1st, monetary officials talked of a need “to re-establish the normal functioning of the overnight money market” bnd accentuated the need for exerting caution.  Remaining monetary stimulus was called “considerable,” and last month’s statement spoke of an “uneven global recovery” and “significant excess supply in Canada.”  Further tightening was to be contingent on both domestic and global economic developments.

Canada has the brightest economic outlook among Group of Seven economies.  Its labor market has been extraordinarily robust.  Jobs expanded leaped 93.2K in June and advanced in the second quarter at a pace equivalent to 573K per month in U.S. non-farm payroll employment.  The IVEY purchasing managers index had an average reading of 60.1 in the second quarter after 53.5 in 1Q.  Flat GDP growth in April followed a sizzling 6.1% annualized pace over the five prior months.  Exports and imports rose between April and May by 6.3% and 6.2%.  Factory sales and orders rose 0.4% and 2.5% in May and by 16.5% and 33.8% from a year earlier.  The index of leading economic indicators gained 1.0% in February, 1.1% each in March, April and May, and 1.0% last month.

Against all that must be weighed the darkening economic situation in the United States, the continuing sovereign debt problems of Europe, heightened worries about Japan, and extremely volatile global financial markets.  The Canadian dollar is 0.5% weaker than on June 1.  10-year bond yields are 8 basis points lower, but a 21-bp rise in 3-month rates discounts a tightening this week.  A Bank of Canada quarterly corporate survey showed a big improvement in sales but an expected smaller pace over the coming three months.  A forward-looking investment component printed at 12 after 22 in the first quarter.

Canadian inflation is quiescent, moreover.  Consumer prices fell 0.8% at a seasonally adjusted rate between February and May, and on-year inflation slid to 1.4% and merely 1.0% if one excludes energy.  Producer prices were also just 1.4% higher than in May 2009, helped by a 2.5 percentage point drag from Canadian dollar strength.  Existing home sales fell 9.5% in May, and housing starts and permits have moved lower.  The trade position had recorded a CAD 1.16 billion surplus in 1Q10 but slid back into the red in April and May.

I suspect tomorrow’s statement will leave hints of a possible policy pause in September.  The next tightening cycle is likely to crest below previous highs. Cyclical central bank peaks were set at 8.0% in 1995, 5.75% in late 2000, and 4.5% in late 2007.

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



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