BOC: “The worst is over”… Or is it?

The Bank of Canada believes that the recession is ending. Spot-on assessment or wishful thinking? They now expect the Canadian economy to grow by 1.3% in the third quarter, compared with the previously estimated 1% contraction. Also, BOC Governor Mark Carney upped his growth estimates for 2010 from 2.5% to 3%. According to Statistics Canada, if the central bank estimates are accurate then Canada is looking at the shortest period of economic contraction, at least since 1957. But is this possible?

During the first quarter of 2009, Canada’s economy narrowed by an annual rate of 5.4% due to declines in retail, manufacturing, and energy output. Retail slid by 0.6%, manufacturing by 1% and mining excluding oil and gas extraction by 3.5%. Canada definitely has a lot of work to do before it can say that the worst is really over…

But wait… there’s more! Canada’s trade deficit swelled to a record of C$1.42 billion in May. This was mainly caused by a 6.9% drop in exports, with weak global demand and the rising CAD as culprits of the drop. According to the government’s export financing agency, the country’s exports will decline by a whopping 21% by the end of the year. Another thorn in Canada’s economy is its consumer price levels, which turned slid down by 0.3% from the year earlier.

On a sunnier note, Carney noted that sharper improvements in the housing industry will be a primary driver in economic growth. Construction activity has been on a rampage as building permits surged by 14.8% in May after falling by 4.5% in April. Housing starts sprung to 141,000 in June, signaling that the housing sector, at least, is already on a rebound.

Another bright spot in the Canadian economy is that the number of job losses tamed in June. Only about 7,400 people lost their jobs as compared to the previous month when about 41,800 employees were fired. Even such a slight improvement in the labor market could raise hopes for better consumer spending. Consumers who believe that the worst is already over are more willing to spend and to take advantage of record-low borrowing costs.

In its rate statement, the BOC said that the reason it kept interest rates unchanged at 0.25% (other than the fact that it really can’t go lower) was that it was seeing some signs of improved economic activity in many sectors of the country. It also repeated that it had no intention of increasing its interest rates until well into 2010.

It seems that very accommodative financial and monetary policies, increased commodity prices, and improved consumer confidence is spurring economic activity. Canada’s report on retail sales for May released last Wednesday showed a 1.2% rise, much better than the 0.5% increase people were initially expecting.

There’s just one not-so-little problem though…. In its interest rate decision last June, the bank voiced out its concern on the CAD’s soaring value versus the USD. The thing is, if CAD’s currency gets too strong, its goods and services would be less favorable to Canada’s trade partners. It makes the value of its goods and services too expensive and therefore decreases overall demand. Economists are saying that a situation like this could just counteract the improvements in other sectors of the country’s economy.

And how exactly did traders react to the news? It appears that traders jumped on the statements concerning the CAD’s rapid appreciation as the USDCAD took a sudden pullback. Yet, the weakening of the CAD could more properly be attributed to overall dollar strength as news concerning CIT’s potential bankruptcy hit the headlines. This, in addition to traders gearing up for US Fed Ben Bernanke’s speech, was probably the reason for the rise in the USDCAD pair.

So where exactly is the Loonie heading? Will recent optimism continue to spur another rally? Will the CAD bust out for a new yearly high against the USD? Or will the threats of currency intervention cause the loonie to lose its punch? As the summer goes on, it’ll be interesting to see whether it will continue to get unusually brighter in the Great White.