Preview: Wednesday’s Bank of Canada Decision is a Very Close Call

September 7, 2010

When a second 25-basis point rate hike to 0.75% was announced on July 20 following a first such increase on June 1, Canadian monetary officials repeated the guiding remark about the future:  “Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.” 

  • Since July 20, the loonie has averaged 1.0401 per USD, near to the present value of 1.0450.  That stability masks a wide trading range from a high of 1.0107 per USD on August 5 to a low of 1.0672/USD on August 31.
  • Investors have become more worried about U.S. economic prospects, and this concern has been reflected in lower long-term interest rates in most countries.  Canada’s ten-year sovereign bond yield, for example, has dropped 29 basis points to 2.87% since July 20, but Canadian stock prices are 3.6% higher on balance.
  • Reported Canadian GDP growth in 2Q10 of 2.0% at an annualized rate was a percentage point less than Canadian monetary officials assumed in their last Policy Report published on July 22.  Net exports exerted a 2.9 percentage point drag on last quarter’s economic growth rate.  The nominal Canadian current account deficit widened to 2.7% of GDP in 2Q from 2.1% in 1Q.
  • The Policy Report in July pushed out the expected time when Canadian excess capacity disappears to the end of 2011 from mid-2011.  The estimated output gap had already narrowed from 3.7% in the summer of 2009 to 1.5% in the second quarter of this year.  After this week, ten regularly scheduled policy announcements remain before the end of next year, but only the first six of those opportunities to lift rates are timely enough to affect Canada’s economy by the time that full employment is expected to be reached.  A gradual 25-bp per shot return to a neutral credit policy setting cannot afford to pass on too many of those six chances.
  • Central bank officials have avoided giving verbal clues regarding what action they are inclined to take in early September.
  • Most other central banks in advanced economies have been more cautious.  The Fed hasn’t eased but has indicated it might.  The Bank of Japan expanded a facility for promoting bank lending.  The ECB will continued its “enhanced credit support” into at least early 2011.  The Reserve Bank of Australia again passed this week, calling its 4.5% cash rate appropriate.  The Bank of England may be considering new quantitative easing.  Sweden’s Riksbank, on the other hand, proceeded with a 25-bp rate increase on September 2nd to 0.75%.  That’s the identical move, size-wise and level-wise, that Bank of Canada officials are considering this week.  Two of the Riksbank’s six-person policy board wanted a more dovish stance.
  • Swedish officials expect their repo rate to have climbed to 2.1% a year from now, 3.1% by 3Q12, and 3.8% by September 2013.  However, they are assuming slightly faster economic growth in Sweden (4.1% this year followed by 3.5% in 2011) than Bank of Canada officials anticipate in their country.  July’s Policy Report from the Bank of Canada projected GDP growth of 3.5% in 2010 and 2.9% in 2011.

The above considerations have mixed implications for what the Bank of Canada policymakers will announce on Wednesday at 09:00 EDT (13:00 GMT).  It’s difficult to handicap this call away from even odds between no change and a 25-bp increase to 0.75%.  If forced to rule out a fence-sitting projection, I’m inclined to believe the central bank will undertake its third increase.

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



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