Loonie Strength Ruffles BOC’s Feathers

For the third time in a row, the Bank of Canada (BOC) decided to keep interest rates on hold at 1.00% as expected. They did acknowledge that Canada‘s economic recovery picked up pace and even upped their 2011 GDP forecast from 2.3% to 2.4%. On top of that, they also predicted that their economy would further expand by 2.8% next year, higher than the previous forecast of 2.6% growth. Sounds to me that these upbeat forecasts deserve a celebratory rate hike!

But don’t get your hopes up just yet. It looks like BOC Governor Mark Carney and his men aren’t in a rush to hike rates soon since the Canadian economy is still haunted by a lot of downside risks. Because of that, policymakers saw it fit to downgrade their growth forecast for the first quarter of this year from 2.6% to 2.5%.

hike.png

Clearly, the BOC is taking the safe route with its decision. It looks to me like it doesn’t want to end up biting off more than it can chew. Considering that there are still quite a number of risks to the economy lingering about, a rate hike at this moment might not really be the smartest thing to do.

Aside from the threats to global growth that the euro zone debt problems bring, Canada’s economy has to deal with economic issues in the U.S. Being joined at the hip to the world superpower is no good when the U.S. is having trouble kick-starting its economy–even with the help of quantitative easing! What will happen when QE2 expires in the second quarter of 2011?! There are just way too many questions and uncertainties involved.

On the domestic front, there are risks as well. The recent rise of the CAD, which recently hit a 31-month high against the U.S. dollar, is threatening Canada’s exports. In fact, its trade surplus with the U.S., to whom Canada sends three-quarters of its exports, fell to its lowest point since 1993 back in September 2010. Check your charts and you’ll see that September is the month the CAD’s strong rally began. Coincidence? Hah!

And now to the question that makes market analysts stare off into space… When will the BOC go back to raising its interest rates?

The BOC has been attempting to hide its hawkish claws by saying that inflationary pressures remain muted and that core inflation is only seen at 2% by the end of 2012. And then, of course, there are also the reasons that I mentioned above.

Still, many speculate that while the BOC might have to hold back by a few quarters, there is a possibility it will have to raise its interest rates earlier than planned. Of course, this prediction comes from those who are expecting a stellar year from the U.S.

There’s a chance the BOC may also implement other policies in order to control its economic growth. The high value of the Loonie is acting as a good tightening measure for now, but the BOC will have to get creative soon if it’s really bent on not raising its interest rate. After all, if the People’s Bank of China could have a bag of tricks for not letting the yuan appreciate despite China’s robust economic growth, then why can’t the BOC think of something to replace an interest rate hike, right?