Wednesday, April 25, 2007

Current Canadian Interest Rate Marketplace HIGHLIGHTS

HIGHLIGHTS of the current marketplace

Easing U.S. core inflation and strengthening retail spending to sooth Fed
Inflation in Canada a concern ahead of next week’s Bank of Canada interest rate announcement

Ask anyone tasked with predicting the direction of
monetary policy in the United States and they’ll
certainly say it has been quite windy on the fence.
Gusts of concern about the persistently elevated
level of core inflation give way to worries about
the economic slowdown with alarming regularity. And
just when there appears to be a consensus supporting
a shift towards a neutral bias, the Fed itself
changes the wind direction (recall the relatively
hawkish minutes to the last FOMC meeting). So it was
a welcome change this week that the flow of economic
data came close to balancing itself out, leaving the
likely woozy Fed-watcher with a moment of calm to
survey the landscape.

The most soothing breeze accompanied March’s
consumer inflation report. All eyes looked beyond
the gasoline-induced rise in total inflation to
focus on the moderation in core, which subsided from
2.7% in February to 2.5%. The core price index
itself rose just 0.06% in the month – marking the
smallest gain in almost two years. More importantly,
the longer term trend in core inflation was also
encouraging, as both the three- (2.3%) and six-month
(1.9%) annualized rates eased in the month. Of
course, a single data point in isolation will not
immediately wash away inflation concerns, but it
represents a step in that direction.

On the other side of the fence, new data this week
suggested that conditions in the housing and
consumer sectors – two areas of particular concern –
may be in better shape than previously thought. The
largest piece of evidence was March’s retail sales
report. The 0.7% increase in headline sales was
largely fuelled by higher prices at the pump,
pushing up the value of sales at gasoline stations.
But the so-called core measure (excluding volatile
sales of autos and those at gasoline stations)
delivered a respectable 0.4% increase. What was even
more encouraging was a large upward revision to
February, which helped boost the three-month
annualized trend in core retail sales to 5.3% from
the relatively anaemic 3.5% pace observed in the
previous month. Even the housing market contributed
an iota of good news as both housing starts and
building permits showed a surprising 0.8% increase
in March. Before breaking out the party hats, it is
important to remind ourselves of the inherent
volatility in this series, which is accentuated by
the fact that virtually all of the new starts were
confined to the Mid-West which in turn was buoyed by
very favourable weather conditions.

So with this week’s economic data presenting a
reasonably balanced view of the U.S. economy, the
key question is, how long the reprieve will last and
on what side of the fence will the final teeter turn
into a tumble? Here, we see the risks staking up on
the downside. As long as the inventory of unsold
homes remains elevated, the housing market will have
further to fall. Meanwhile, the consumer has been
able to weather the loss in wealth from falling home
prices, but they will increasingly have to rely on
other sources of income to sustain their spending.
So far, the labour market has been up to the task,
generating modest employment growth accompanied by
wage gains. Provided that the job market is not
undermined by the recent weakness in business
investment, we believe the Fed will leave rates
unchanged, especially if inflation fails to cool

Inflation on the radar in Canada

Canada’s invitation to the elevated-inflation party
must have been delayed in the mail. But now that it
has arrived, inflation has jumped to the forefront
for financial markets, especially with the Bank of
Canada set to announce their next interest rate
decision next week. Indeed, particular attention was
paid to Thursday’s CPI report for the month of
March. And here, the data was tipped to the
encouraging side in that core inflation backed
modestly away from its recent 2.4% peak set in
February, settling at 2.3%. However, March was the
ninth consecutive month that core inflation was at
or above the Bank’s 2% target. Within the details,
shelter costs continue to play an important, albeit
lessening role in keeping core inflation elevated.
With new home price appreciation expected to cool
across Western Canada, there should be further
easing within this component which will help
alleviate some of the upward pressure on inflation
in the quarters to come.

Despite the slight moderation in March and a cooling
housing market in Western Canada, an above-target
rate of core inflation will be a familiar sight in
the months to come – reflecting the fact that the
economy is operating at its productivity capacity.
While the labour market, with its unemployment rate
at a generational low, stands out as an example of
this reflection, the business sector is following
closely behind. Not only did the Bank of Canada’s
Business Outlook Survey note heightened optimism
among firms, but that capacity constraints were also
increasing. Seeing through the weather-induced fall
in February’s inflation-adjusted retail sales, the
domestic economy remains extremely healthy.
Meanwhile, an evaluation of the trade side, which is
still Canada’s pocket of weakness, has been obscured
to varying degrees by the 15 day CN Rail strike in
February. The greatest effect was captured last week
with the release of international trade which showed
a pronounced decline in exports. This week,
manufacturing shipments also were down, but not by
as much as one would expect – suggesting some
underlying strength. Similarly, wholesalers shrugged
off the strike entirely and registered a surprise
0.8% gain in February. It will take another month or
so of data to see through this volatility, which in
turn will help keep the Bank on hold next week,
although a greater acknowledgement of the risk to
inflation may be warranted. Indeed, the Bank will
have the perfect opportunity to do so in detail next
week with the release of the Monetary Policy Report
on Thursday. Article Courtesy of R.Paul Chadwick Manager of Residential Mortgages, TD Canada Trust

Read more about the current state of the real estate market

Toronto Real Estate Board (TREB) Average Prices and Graph

For more information please contact A. Mark Argentino

A. Mark Argentino, Broker, P.Eng.,
Specializing in Residential & Investment Real Estate
RE/MAX Realty Specialists Inc., Brokerage
2691 Credit Valley Road, Suite 101, Mississauga, Ontario L5M 7A1

BUS. 905-828-3434
FAX. 905-828-2829

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