Thursday, September 09, 2010

Explanation of Bank of Canada Interest rate increase - September 9, 2010

This might shed some light why the bank rate was increased today, directly from TD Economics, all the best!


TD Economics

September 8, 2010

Data Release: Bank of Canada hikes quarter point, but provides little guidance for the future

The Bank of Canada lifted the overnight rate by a quarter point to 1.00%.

The accompanying communiqué was exceptionally brief, providing limited guidance to markets

as to future actions.

The Bank highlighted the uneven nature of the global economic recovery and noted the factors

restraining U.S. demand. It remarked that the Canadian economy had underperformed the

Bank's expectations in the second quarter, but stressed that domestic strength is expected to

continue. The Bank indicated that it will be scaling back their Canadian economic growth

forecast slightly in the October Monetary Policy Report (MPR), but few details were provided

other than that the lower forecast will reflect a weaker profile for U.S. economic growth.

Importantly, the Bank noted that inflation has been in line with expectations and the dynamics

for prices are unchanged – this is interesting given the recent deceleration in core inflation.

The communiqué emphasized that financial conditions in Canada remain "exceptionally

stimulative" and it maintained the refrain that "Any further reduction in monetary stimulus

would need to be carefully considered in light of the unusual uncertainty surrounding the


Key Implications

It is evident from the communiqué that the Bank is in highly reactive mode. In the absence of

clarity surrounding the outlook, there is no commitment or hint to either a pause in the

tightening cycle or the continued gradual nudging of interest rate higher. Key economic and

financial indicators over the next six weeks will ultimately decide the next decision on October


In our opinion, the odds favour the Bank of Canada pausing for some time. And, TD

Economics does not anticipate another tightening before March of next year.

Since the start of this year, the Bank's outlook for economic growth in 2011 has been too

rosy. Their forecast for real GDP growth in 2011 has been steadily ratcheted downward, from

an expectation in January of 3.5%, down to 3.1% in April, sliding to 2.9% in July. Our view is

that the July MPR projection is far too high, although the fact that the Bank suggests that only

a slightly more gradual recovery is expected raises the possibility that the Bank remains too

optimistic. In the opinion of TD Economics, the Canadian economy will be hard pressed to

expand by 2% next year. The economy faces both external and domestic headwinds. On the

external front, the U.S. economy is likely to grow at only a 2% pace in 2011 and a moderation

in global demand growth is likely to cap the upside to commodities – both of which pose a

constraint on Canadian exports. On the domestic front, a weaker housing market will dampen

residential investment and temper consumer spending on big-ticket items. Moreover, the high

indebtedness of Canadian households is also likely to act as a serious constraint on outlays

even in a continuing low interest rate environment. TD Economics expects Canadian

economic growth to average an annualized 1.8% in the second half of 2010 and an average of

1.9% in 2011. While the Bank anticipated in July that the economy will be back to full capacity

by the end of 2011, TD Economics anticipates that it will take at least two quarters longer to

reach that goal.

The implication is that soft economic numbers are anticipated in the coming months. Indeed,

we expect that the unemployment rate could edge higher in the near term and core inflation is

expected to dip towards 1.4% in early 2011. This outlook suggests that a pause in the

tightening cycle could easily occur.

No comments:

Post a Comment