Paul Vieira Financial Post March 7, 2011
OTTAWA — The improving economic backdrop has strengthened some economists’ view that the Bank of Canada will begin raising its benchmark rate in the – either in April or May – or at the very least in July, once the U.S. Federal Reserve is scheduled to end its US$600-billion asset purchase plan.
Not so the Bank of Nova Scotia. It is among the few research houses on Bay Street that believe the Bank of Canada, led by governor Mark Carney, will wait much longer – to October to be more precise. (Meanwhile, analysts at Capital Economics have reiterated their view the central bank remains on hold for all of 2010.) The main culprit: A weak U.S. dollar which could drive the loonie to US$1.08 by the end of the year.
Scotiabank economists Derek Holt and Gorica Djeric offered a detailed explanation of its view in a note to clients. Here is a summary of Scotiabank’s arguments:
• THE GREENBACK WILL KEEP SLIDING
Scotiabank is just plain bearish on the U.S. currency, as the Federal Reserve continues to pump cash into the system and keep its benchmark rate near zero. But the bank also believes there is a chance the White House further extends stimulus measures agreed upon late last year as opposed to allowing them expire – likely earning a rebuke from bond raters and fixed-income investors as Washington’s fiscal status would deteriorate further. That, in turn, would make the U.S. dollar even less favourable and likely adds to the loonie’s strength.
That could drive the loonie to as high as US1.08¢ by the end of 2011 — a full 12 cents above the most dovish view on the loonie, Scotia admits.
“This type of CAD strength imposes net tightening on the Canadian economy that we believe will do the Bank of Canada’s tightening for them. It is difficult to envision further Bank of Canada tightening when our expectation is that Canadian dollar will be lit up apart from what the Bank of Canada does.”
• GLOBAL UNCERTAINTY WILL CONTINUE
Turmoil in North Africa and the Middle East, and the impact that is having on energy prices, justifies the central bank keeping its powder dry for now. “No one has a clue as to how various geopolitical developments … will fully unfold,” Scotiabank said.
Also lurking in the background is Europe’s sovereign debt worries, and what policy makers will eventually agree to at a summit late this month.
• ECONOMIC SLACK REMAINS WIDE
Despite the better-than-expected fourth-quarter growth data, it likely didn’t have much of an impact on the country’s output gap that according to the last Bank of Canada estimate stood at 1.9% of the economy, Scotiabank said. It added it foresees risks to demand growth from government spending cuts, high commodity prices and new mortgage rules.
Furthermore, recent historical evidence would suggest there is a weak link between a narrowing output gap and inflationary pressure, especially since the Bank of Canada adopted an inflation-targeting regime about 20 years ago.
• TIGHTENING ALREADY UNDERWAY
There are developments underway which have the same impact as a rate hike, from a higher Canadian dollar; tougher mortgage financing rules which begin to take effect this month; the withdrawal of government stimulus; and, eventually, higher bond yields which will translate into higher rates on consumer loans.
• DOVISH FED
Fed chairman Ben Bernanke continues to signal a cautious, dovish approach, with expectations rate hikes begin sometime next year. Raising rates in Canada now would just push an already strong loonie higher.
• INFLATION TARGETING REGIME
It is still not clear what the Bank of Canada’s inflation-targeting regime will look like once it is renewed at the end of the year. “Therefore, it’s not clear to us if the Bank of Canada hikes the minute its operational core target gets to 2% in this cycle or is expected to do so,” Scotiabank said.
• FEDERAL & PROVINCIAL ELECTIONS
It remains unclear about whether the federal parties go on an election campaign this year once the federal budget is tabled on March 22. Still, Scotiabank said the central bank has raised rates only once during an election campaign in the last 20 years – in 2006, when the strong economy justified a hike – and will likely show caution again. Compounding matters are a series of provincial elections due in 2011, including Ontario where incumbent Premier Dalton McGuinty has repeatedly voiced concern about rate hikes and the upward push it provides to the Canadian dollar.
http://business.financialpost.com/2011/03/07/why-the-boc-wont-raise-rates-until-october/
Friday, March 11, 2011
Central bank may still hike rates before summer
Andrew Pyle, On Friday March 4, 2011,
The Bank of Canada has now kept its official interest unchanged at 1 per cent for the fourth meeting.
Those with floating-rate debts will no doubt be relieved; however, economists were looking for a signal from Mr. Carney and crew that improving economic conditions were paving the way for a return to rate hikes sometime soon.
Had this week's policy meeting taken place a few weeks ago, it's likely we would have received that signal. Indeed, most indicators have pointed to stronger-than-expected activity in Canada and the U.S., while emerging economies have maintained a torrid pace of growth.
That would have been before the recent developments in Egypt, Tunisia, Yemen and now Libya. The grassroots uprising against incumbent regimes might be welcome from a democratic ideal perspective, but it has created a rift in energy markets.
Crude awakening
After dipping briefly below $85/barrel in February, the price of crude oil has now broken above $100 for the first time since October 2008, testing $103.40 last week — the 61.8 per cent retracement mark from the July-December 2008 collapse.
A close above this level will increase the odds of a move to $120 (recall that $147.27 was the intraday high from July 2008). And if you thought the recent spike in pump prices was unnerving, gasoline futures have already crossed above the 61.8 per cent retracement level and are trading above three bucks (US) a gallon.
In July 2008, futures broke above $3.70/gallon. Even if prices simply hold near current levels, average pump prices in Canada could easily gravitate towards $1.30/litre. That's not good news for those planning to drive to their March break vacation spots, or for those returning snowbirds.
One might suspect the Bank of Canada would see the boost to inflation, that will come from commodities like oil and gasoline, as something that needs to be worked against through tighter monetary policy, but that's old school.
These commodities, like food (which is also seeing some inflation strain), are essentials and represent a significant share of our non-discretionary spending. Unless incomes rise by the same amount as the cost of these essentials, everything else being different, there will be less to spend on discretionary goods and services. In other words, real consumption growth in Canada could slow.
Not so fast
How much of a slowdown we experience in consumer spending (and let's throw in housing expenditures too), depends greatly on that above-mentioned phrase "all other things being equal."
If employment grows at a decent clip and wages go with it, then the affect on spending will be less pronounced. As of the end of 2010, average weekly earnings in Canada were up 4.5 per cent over the same period a year ago, which was the fourth-best growth rate in earnings since records started in the early 1990s.
To put this in perspective, when crude oil was climbing towards $150 back in the summer of 2008, weekly earnings growth was heading in the opposite direction.
There were other headwinds facing Canada back in 2008, including the cost of borrowing. When oil reached its peak, the 5-year conventional mortgage rate in Canada was above 7 per cent. Today, it sits near 5.5 per cent. The 1-year rate was also close to 7 per cent (yes, we had a very flat yield curve before the walls came tumbling in), compared to 3.5 per cent today.
Now, I'm not suggesting that we're going to stay in interest rate limbo forever, but the Canadian consumer is in better shape to handle higher pump prices today than back two years ago.
How long can they sit on the fence?
What the Bank of Canada has to be careful of here is the oil price shocks emanating from across the pond turn out to be temporary and there is no slowdown in consumption growth. Bank economists are already looking towards 2012 as the likely period where excess capacity in Canada's economy disappears and inflation returns to target (using the core inflation measure).
It is easy, however, to accelerate that trip back to zero excess and just as easy to push the economy into a situation of excess demand.
Coming back to the Bank's decision this week, it may have been surprising to see it lean against speculation of near-term tightening. But, it would be a mistake to assume the Bank can't and won't pull the trigger on rates before the summer.
There are two policy meetings left this half (April and May), so if Mr. Carney and crew wake up and realize there is too much potential inflation risk in leaving rates unchanged, they will need the April meeting to deliver the guidance towards a May rate hike — something economists thought was going to happen this week.
And if energy price shocks don't intensify and the Bank fails to deliver such guidance, don't be surprised if the bond market creates the guidance for them.
http://ca.finance.yahoo.com/news/Central-bank-still-hike-rates-yahoofinanceca-1276928971.html
The Bank of Canada has now kept its official interest unchanged at 1 per cent for the fourth meeting.
Those with floating-rate debts will no doubt be relieved; however, economists were looking for a signal from Mr. Carney and crew that improving economic conditions were paving the way for a return to rate hikes sometime soon.
Had this week's policy meeting taken place a few weeks ago, it's likely we would have received that signal. Indeed, most indicators have pointed to stronger-than-expected activity in Canada and the U.S., while emerging economies have maintained a torrid pace of growth.
That would have been before the recent developments in Egypt, Tunisia, Yemen and now Libya. The grassroots uprising against incumbent regimes might be welcome from a democratic ideal perspective, but it has created a rift in energy markets.
Crude awakening
After dipping briefly below $85/barrel in February, the price of crude oil has now broken above $100 for the first time since October 2008, testing $103.40 last week — the 61.8 per cent retracement mark from the July-December 2008 collapse.
A close above this level will increase the odds of a move to $120 (recall that $147.27 was the intraday high from July 2008). And if you thought the recent spike in pump prices was unnerving, gasoline futures have already crossed above the 61.8 per cent retracement level and are trading above three bucks (US) a gallon.
In July 2008, futures broke above $3.70/gallon. Even if prices simply hold near current levels, average pump prices in Canada could easily gravitate towards $1.30/litre. That's not good news for those planning to drive to their March break vacation spots, or for those returning snowbirds.
One might suspect the Bank of Canada would see the boost to inflation, that will come from commodities like oil and gasoline, as something that needs to be worked against through tighter monetary policy, but that's old school.
These commodities, like food (which is also seeing some inflation strain), are essentials and represent a significant share of our non-discretionary spending. Unless incomes rise by the same amount as the cost of these essentials, everything else being different, there will be less to spend on discretionary goods and services. In other words, real consumption growth in Canada could slow.
Not so fast
How much of a slowdown we experience in consumer spending (and let's throw in housing expenditures too), depends greatly on that above-mentioned phrase "all other things being equal."
If employment grows at a decent clip and wages go with it, then the affect on spending will be less pronounced. As of the end of 2010, average weekly earnings in Canada were up 4.5 per cent over the same period a year ago, which was the fourth-best growth rate in earnings since records started in the early 1990s.
To put this in perspective, when crude oil was climbing towards $150 back in the summer of 2008, weekly earnings growth was heading in the opposite direction.
There were other headwinds facing Canada back in 2008, including the cost of borrowing. When oil reached its peak, the 5-year conventional mortgage rate in Canada was above 7 per cent. Today, it sits near 5.5 per cent. The 1-year rate was also close to 7 per cent (yes, we had a very flat yield curve before the walls came tumbling in), compared to 3.5 per cent today.
Now, I'm not suggesting that we're going to stay in interest rate limbo forever, but the Canadian consumer is in better shape to handle higher pump prices today than back two years ago.
How long can they sit on the fence?
What the Bank of Canada has to be careful of here is the oil price shocks emanating from across the pond turn out to be temporary and there is no slowdown in consumption growth. Bank economists are already looking towards 2012 as the likely period where excess capacity in Canada's economy disappears and inflation returns to target (using the core inflation measure).
It is easy, however, to accelerate that trip back to zero excess and just as easy to push the economy into a situation of excess demand.
Coming back to the Bank's decision this week, it may have been surprising to see it lean against speculation of near-term tightening. But, it would be a mistake to assume the Bank can't and won't pull the trigger on rates before the summer.
There are two policy meetings left this half (April and May), so if Mr. Carney and crew wake up and realize there is too much potential inflation risk in leaving rates unchanged, they will need the April meeting to deliver the guidance towards a May rate hike — something economists thought was going to happen this week.
And if energy price shocks don't intensify and the Bank fails to deliver such guidance, don't be surprised if the bond market creates the guidance for them.
http://ca.finance.yahoo.com/news/Central-bank-still-hike-rates-yahoofinanceca-1276928971.html
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