Special Report-BOC may signal rates will soon begin to rise
Monday, April 19th, 2010The Bank of Canada (BOC) will hold a policy meeting on Tuesday, April 20th. At the March policy meeting the BOC left interest rates unchanged at a record low 0.25% and said that inflation and economic growth had been higher than expected. The BOC reaffirmed its commitment to maintaining yields at the record low level through June 2010 conditional on inflation. The March policy statement said that Canada’s domestic economic activity had been slightly higher than projected in its January report and the recovery in exports continues. The recovery is supported by policy stimulus, increased confidence, improved financial conditions, global growth and higher terms of trade. Strength of the CAD and low demand from the US act as drag on the Canadian recovery. Recent Canadian economic data confirms faster growth and higher inflation. Canada’s economy expanded at its fastest pace in three years in January and the trade surplus grew for the fifth straight month with exports rising by 2.8% in February. Canada created 17,900 new jobs in March and inflationary pressures are building. Canada’s annual core inflation rate accelerated to 2.1% in February. The BOC’s Business Outlook survey released on April 12th states that 40% of Canadian executives surveyed expect inflation to rise by 2 to 3% over the next two years. This is up from 20% of executives in January. BOC inflation target is 2%.
CAD is trading near 22 month high versus the USD recently breaking above parity. According to a Bloomberg report of 12 Canadian primary dealers the BOC is expected to hold rates steady at April 20th policy meeting. Because of faster than expected Canadian growth and building inflation pressures the BOC is expected to signal that rates will soon begin to gradually rise. BOC Governor Carney last month said that he was open to raising interest rates as soon as June 1st because inflation and growth has been faster than forecast. BOC interest rates have been held at a record low of 0.25% since April 2009. The BOC said that it would maintain rates at this low level through June of 2010 conditional on inflation. The BOC is widely expected to shift its policy guidance Tuesday and open the door for a possible rate hike as soon as June or July.
The impact of a shift towards a tightening bias by the BOC may be limited because investors are anticipating the BOC will soon raise interest rates and the CAD has been strong. Investors will be looking to see whether the BOC makes reference to the strength of the CAD or the prospect for Yuan revaluation. Strengthening CAD and Yuan revaluation are seen as a potential drag on the Canadian and global recovery. If the BOC maintains its current bias and states concern about the outlook for the recovery, CAD could experience significant selling pressure. This seems unlikely in light of faster growth and higher inflation in Canada. The real question appears to be whether the BOC hikes rates in June or July.
According to analysts at RBC Capital Markets there is a 50% chance that the BOC will increase rates in June and the RBC is leaning towards a July rate hike. According to analysts at the Royal Bank of Canada the BOC will raise interest rates 25bps in July and to1.25% by year end. The key issue is whether the BOC is more concerned about inflationary expectations or rate hike expectations. Inflationary expectations could undermine BOC credibility and hurt long term Canadian economic growth. Rate hike expectations would boost demand for the CAD and could hurt the recovery. We suspect that the BOC is more concerned about inflation and will signal at Tuesday’s meeting that rate increases are coming. Investors will be looking at the language of the BOC policy statement for clues to whether rate hikes will begin in June or July. If The BOC drops its conditional inflation language it would open the door for a June rate hike. At a minimum we expect the BOC to shift to a more hawkish bias because of inflationary pressures. The BOC’s Monetary Policy Report will be released Thursday. The report should contain more clues about BOC policy direction. Canada’s March CPI will be released on Friday April 23rd. The March annual inflation rate is expected to rise to 1.7% from 1.6% in February. The annual core inflation rate is expected to drop to 1.9% from 2.1% last month
Written by Easy-Forex
