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Bank of Canada Hikes Rate Quarter Point

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 outlook.”

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 20.

• 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.

Craig Alexander, SVP and Chief Economist

Check out the link below to an article in the Globe and Mail titled: “Why Rising Rates Haven’t Hurt Housing”. In this article there’s some commentary by Craig Alexander, Chief Economist at TD Bank.

Read article


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