Based on how the global economy is faring and how most central banks are behaving, it’s hard to imagine that there’s one that’s actually thinking of tightening monetary policy. Earlier this month, the Bank of England (BOE) expanded their asset purchase program while the European Central Bank (ECB) slashed interest rates by 0.25% to provide additional support for their economies.
Even the world’s top two economies are shaking in their boots as the People’s Bank of China (PBoC) surprised the markets by cutting rates twice in less than a month while policymakers at the U.S. Federal Reserve (Fed) revealed that they were mulling further easing measures.
Enter the Bank of Canada (BOC), the rose among the thorns, the diamond in the rough, the lone hawk surrounded by doves. Although the Canadian central bank kept rates on hold at 1.00% during their latest policy decision, BOC policymakers revealed that “some modest withdrawal of monetary stimulus” may be appropriate sooner or later.
What in the world is the BOC so upbeat about?
Apparently, central bank officials think that the strength of the domestic economy would be enough to keep growth sustained despite persistent global headwinds. They expect consumption and business investment to be the major drivers of growth as they expect the Canadian economy to expand by 2.1% this 2012 and continue to pick up pace over the next couple of years.
BOC officials are also confident that the current excess supply in Canada will eventually be absorbed and that their economy will soon be able to maximize its production potential. Once that happens and the Canadian economy is able to meet the 2% inflation target, the BOC might decide to tighten its monetary policy.
Will this happen anytime soon? This year, perhaps?
Naysayers are quick to point out that, even on the domestic front, the Canadian economy still has a few problems to deal with. For one thing, production and spending dipped slightly as business and consumer confidence were dampened by the ongoing euro zone debt crisis.
On top of that, Canada’s export industry is also suffering due to the slowdown in the global economy. Nearly 75% of Canada’s exports are shipped to the U.S., where employment and demand are currently in a slump. This forced several Canadian companies to reduce prices in order to boost overseas demand for their products.
What do all these mean for the Loonie?
Despite the internal and external risks that are still present, positive interest rate expectations are likely to keep the Canadian dollar supported in the near term. After all, the BOC seems to be the only major central bank that isn’t looking to add to its stimulus efforts at the moment!
As discussed in the Interest Rates 101 lesson in the School of Pipsology, most traders price in their interest rate expectations way before the actual rate cut or hike takes place. More often than not, what’s more important is where interest rates are EXPECTED to go.
Bear in mind that the Loonie is also supported by rising oil prices. In fact, if fuel price rallies are strong enough to push annual inflation above the BOC’s 2% target, the central bank might actually hike rates just to keep price levels in check.
Do you think that this is likely to happen before the end of this year? Let us know by voting through the poll below!