Bank of Canada holds rate, but eyes inflation

Date: March 2nd, 2010

Paul Vieira, Financial Post

OTTAWA — The Bank of Canada reiterated on Tuesday its conditional pledge to keep its key-lending rate at a record low until July, but took a more hawkish view on inflation by indicating the risks to its outlook are “roughly balanced” as opposed to tilted to the downside.

That was the one significant change in its scheduled interest-rate announcement, and analysts might interpret this as a first step by the central bank to ready markets for an interest-rate hike.

“The Bank of Canada is now walking not crawling towards the exit,” said Kathy Lien, director of currency research at, following the release of the statement.

“Change is afoot. Evolutionary change, but change nonetheless,” added Stewart Hall, economist at HSBC Securities Canada.

Markets reacted accordingly, sending the Canadian dollar up sharply, over 80 basis points to US96.83 as of trading at 9:30 am ET.

For nearly a year, the central bank has pledged to keep its benchmark rate at 0.25% until July in an effort to pump up economic growth, on the condition that inflation would not hit its preferred 2% target until mid-2011. The central bank’s mandate is to set its key policy rate at a level to achieve 2% inflation.

In previous statements, the central bank had suggested inflation risks were titled downward because of the possible need to engage in quantitative easing, in which the Bank of Canada would flood financial markets with cash in an effort to spur lending and combat deflation.

But through the statement, the central bank might be indicating deflation is no longer a concern.

“The bank judges that the main macroeconomic risks to the inflation projection are roughly balanced,” it said, with upside risks being stronger-than-projected growth, while a protracted recovery and strong Canadian dollar flagged as downside risks.

Mr. Hall said this shift in nuance was “indicative of the need for a policy change at some point.”

The change in the inflation outlook emerged after Statistics Canada reported that the economy grew at a 5% annualized rate in the fourth quarter of last year – blowing past market expectations for a 4% gain and the central bank’s original 3.3% forecast. Economists say the fourth-quarter performance has set the stage for another robust gain, of perhaps 4% or more, for the first three months of 2010.

Recent data indicate that both the headline and core inflation rates have moved much closer to the 2% level than the central bank had expected. Under the bank’s forecast, the 2% level would not be reached until the third-quarter of next year.

“Core inflation has been slightly firmer than projected, the result of both transitory factors and the higher level of economic activity,” the central bank said in its one-page statement. “The outlook for inflation should continue to reflect the combined influences of stronger domestic demand, slowing wage growth, and overall excess [economic slack].”

In its economic outlook in January, the central bank said stubborn unit labour costs along with increases in property taxes and other administered prices accounted for the recent “stickiness” of core inflation.

The longer inflation stays “sticky,” analysts say, the more likely that the output gap, or the measure of excess economic capacity, is narrowing at a faster pace than previous central bank expectations.

The bank has said it anticipated the output gap to close in the third quarter of 2011. A large amount of excess production capacity suggests a lack of consumer demand, and gives producers little to no pricing power.

Meanwhile, the central bank also acknowledged that economic activity has been “slightly higher” than its own projections, with the 5% gain in the fourth quarter powered by “vigorous domestic demand” and a recovery in exports.

“The underlying factors supporting Canada’s recovery are largely unchanged – policy stimulus, increased confidence, improved financial conditions, global growth and higher terms of trade,” the bank statement said.

It added that “persistent strength” in the Canadian currency and the “low absolute level” of U.S. demand would continue to act as “significant drags” on economic activity.

“The Bank of Canada has walked a fine line with its latest decision, though overall it is undeniable that the risks to Canadian monetary policy are starting to tilt upwards,” said Eric Lascelles, chief economics and rates strategist at TD Securities. He added the firm’s view was that the central bank would not begin raising rates until the fourth quarter, “but it is hardly inconceivable that this could now come a touch sooner, in September or possibly even July.”

The central bank’s next statement on interest rates is April 20, and two days later it will release its updated economic forecast. Meanwhile, the governor, Mark Carney, has scheduled two speeches this month in which he may provide further guidance as to how the bank would behave as its conditional pledge comes to an end.

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Bank of Canada Expected to Retain 0.25% Key Interest Rate Tues

Date: March 1st, 2010

By Courtney Tower

OTTAWA (MNI) – Financial markets looking for guidance likely will find little to move them, either up or down, in the Bank of Canadas policy rate announcement Tuesday.

It is a given among analysts that there will be no change to the central banks historically low 0.25% overnight rate, Tuesday (9:00 a.m. ET/1400 GMT) or in the subsequent rate announcement April 20.

There is no reason in Canada’s economic posture, with plenty of slack and low productivity, or in United States and world recovery (slow and disappointing) to persuade the Bank to alter its pledge to keep the fiscal stimulus at 0.25% through this years first half.

Most expect little change, either, in the short BOC policy statement about its reading of the future about the slack in the economy and reflecting little concern about inflation.

The numbers on are surprisingly strong, the core having reached the Bank’s 2.0% target in January. But this level is expected to be short-lived, said Diana Petramala of TD Economics. She wrote that the spike to 2.0% was largely due to “a base-year effect … prices fell significantly in January of 2009.”

“Looking forward, a persistent output gap will keep inflation under wraps for 2010, and the Bank of Canada will be able to keep its commitment on holding the rate through the first half,” Petramala wrote.

Analysts see little help for Canadian exports coming from U.S. demand, either, despite marked economic growth in the past three months. They see this spurt as temporary, based on restocking of inventories and driven by public stimulus programs rather than by a sustained private recovery.

All in all, writes Avery Shenfeld of CIBC Economics, “look for the Bank to wait even longer than promised, until early 2011, to pull the trigger on rate hikes.”

Shenfeld adds: “There is simply no need for the Bank of Canada to hurry up and tighten.”

He sees fiscal as well as monetary policy remaining stimulative all year, as repeatedly pledged by Finance Minister Jim Flaherty who brings down a new federal budget Thursday. For this year overall, despite encouraging GDP numbers in the early going, Shenfeld sees only “a half-speed, 2% recovery.”

Canadian GDP results for the fourth quarter of 2009, published by Statistics Canada Monday, will not influence immediate Bank of Canada thinking, analysts believe, although they might, if continued, cause rate hikes to begin later this year.

The economy expanded at a 5.0% annualized rate in the fourth quarter of 2009, faster than the 3.3% gain predicted by the Bank of Canada and stronger than most analyst expectations of a 4.2% to 4.5% increase.

The fourth quarter growth in GDP was the strongest since the third quarter of 2000, Statistics Canada said. It was broadly based, including a further increase in exports over imports, continued consumer spending and continued housing strength.

About the only negative aspect of the fourth quarter was that business investment in plant and equipment fell by 2.3% after rising by 1.6% in the third quarter. All major categories of business machinery and equipment investment declined.

A key argument for the Bank maintaining its 0.25% rate is that Canadian productivity is lagging quite seriously and the output gap is considerable. The falling business investment in plant and equipment supports that argument.

Nine university and private industry economists gathered together by the think tank C.D. Howe Institute unanimously call on the central bank to stand fast Tuesday. Eight of the nine would have it do the same in April. After that, they favor gradual rate hikes of 25 and 50 basis points.

These economists, like others surveyed, were concerned about “recent disappointing indicators in the United States and relative stagnation in Europe and Japan,” in contrast to continuing strong Canadian domestic indicators and strength in Asia.


Date: February 26th, 2010

The recent increase in the US Fed Discount Rate means very little in practical terms. The discount rate is the interest rate that the Fed charges banks for emergency loans and it is hardly being used. The rate hike however, signals the first step in a long journey towards removing liquidity from the system.

The move makes sense given that the Fed has closed many of its emergency lending facilities and demand for funding has slowed substantially. In fact, borrowing from this credit facility has totaled only $20 billion over the past three months. Given that normally the gap between the discount rate and the fed funds rate is 100 basis points and today, it is standing at 50 basis points suggests that we might see an additional increase in this rate in the near future. What counts, however, is the fed funds rate and this rate is unlikely to rise until early 2011.

As for the Bank of Canada, at this point it appears that the Bank is committed to start hiking come June or July. This is a risky move given that both in 1992 and 2002 the Bank moved independently of the Fed, only to reverse the decision a few months later. The most likely scenario is that the Bank will move by 50-75 basis points and then will pause until 2011 and continue to hike alongside the Fed.

The reason for the limited hike in 2010 is that the ongoing recovery in the Canadian economy will not be linear. The first two quarters of the year will be strong, reflecting fiscal stimulus from both sides of the border, a rebounding inventory cycle and strong credit growth in Canada. These factors, however, will fade in the second half of the year, with overall GDP growth expected to average less than 2% vs. more than 3% in the first half.

As for inflation, the Bank of Canada is projecting core inflation to reach its target rate of 2% by mid-2011. But the core rate has already reached 1.9% last month. Is the Bank of Canada wrong? The short answer is no. The 1.9% advance in the core rate reflects a very soft base period (rates are calculated on a year-over-year basis and January of 2009 saw a notable decline in prices). This means that the coming months will see a much lower inflation rate. The reality is that the underlying inflation rate in Canada is well below 1.5%. So we still have a lot of time until we reach the Bank’s target.

The recent move by the Ministry of Finance towards more stringent regulation of home loans is targeted to deal with potential problems down the road without derailing the housing market.

Canadian Finance Minister Tightens Mortgage Rules

Date: February 16th, 2010

Finance Minister Jim Flaherty Tuesday announced tighter lending standards for mortgages, saying that while the housing market is “healthy” the moves are needed to “help prevent negative trends from developing.”

Under the new rules, all borrowers will need to meet standards for 5-year fixed-rate mortgages regardless of whether they’re seeking a loan with a lower rate and shorter term.

Also, the government is lowering the maximum amount Canadians can withdraw when refinancing to 90 per cent of the value of their homes, from the current 95 per cent, and requiring a 20 per cent down payment for government-backed mortgage insurance on “speculative” investment properties.

“There are no definitive signs of a housing bubble,” Mr. Flaherty said. “We think we’re being pro-active in the three steps we’re taking today.”

Frank Techar, the President of Personal and Commercial Banking for BMO Bank of Montreal, welcomed the announcement.

“While we do not believe that Canada faces a housing bubble, we fully support the minister’s actions,” Mr. Techar said in a statement. “Given the prospect of higher interest rates and the recent run-up in housing prices in some markets across Canada, the measures announced today are prudent. Currently, we require high ratio mortgages to be able to qualify using the 5 year rate.”

In a release, the finance department indicated that the three new changes to the mortgage insurance guarantee rules are intended to take effect April 19, 2010.

Mortgage terms may be too lax, former BoC governor says

Date: February 11th, 2010

John Greenwood, Financial Post

The former head of the Bank of Canada has jumped into the debate over the housing market, warning that prices have reached a point where they are almost unsustainable.

“One would have to say that the relation of house prices to Canadians’ income is right at the high end of what one would think would likely be sustainable over time,” David Dodge told Business News Network on Wednesday.

Mr. Dodge, the central bank chief from 2001 to 2008 said the remedy is not necessarily higher interest rates. Rather, the Canada Mortgage and Housing Corp. should start scrutinizing more closely the kind of mortgages that it insures.

“That’s not to say the Bank [of Canada] ought to somehow raise interest rates really quickly, but it does say that [CMHC] should be very careful about the terms and conditions on which they are giving mortgage insurance,” he said.

As part of Ottawa’s policy to encourage home ownership among Canadians, the CMHC provides insurance for higher-risk home buyers such as those who are unable to make a 20% down payment, enabling people who would not otherwise be able to get a mortgage to enter the market.

The CMHC also guarantees billions of dollars of mortgages that are converted into Canada mortgage bonds and sold to investors.

Mr. Dodge said we’re “getting to a stage where one begins to get quite nervous” about the ability of some consumers to pay off their mortgages if rates rise. He notes that it is “clearly appropriate” to have very low interest rates because of the economic recovery and where rate stand in the rest of the world. He said that is why it’s more relevant to look at the “terms and conditions” of mortgages to deal with this issue.

The comments come less than a week after Jim Flaherty, the finance minister, said there is no compelling evidence of a housing bubble in Canada.

With residential real estate prices across the country close to record highs, many observers have expressed concern about the state of the market particularly with the run up that took place in the months since the financial crisis.

The concern is that when interest rates rise starting later this year many Canadians could find themselves struggling to make their payments. And if the economy reverses course at the same time — as some economists predict — the situation would be exacerbated, with serious negative implications for the housing market.

Moody’s warned last month that expanding consumer debt levels could leave Canada in a worse position than the United States in the next few years if current trends continue.

“We believe the housing market is the principal driver of this expansion,” said the report by Peter Routledge, senior vice-president at the rating agency. “We have the uneasy sense that we have seen this movie before…. As witnessed in the United States, this movie does not end well.”

Many blame the meltdown south of the border on the availability of cheap credit even to people with no chance of meeting their obligations.

While nothing in Canada compares to the subprime market in the United States, the CMHC mortgage insurance program enables lenders to offer cheaper mortgages to a wider range of borrowers.

At the same time, the CMHC’s mortgage bond progra — the underlying loans are also guaranteed by the agency — creates incentive for banks and other lenders to sell more mortgages by providing access to hundreds of billions of dollars of cheap funding.