On 1/18/2011, The Bank of Canada (BoC) announced it is maintaining its overnight interest rate at 1%. The Bank Rate is correspondingly 1.25% and the deposit rate is 0.75%.
Canada’s Weak Net Exports & High Household Debt
The move reflects the central bank’s observation that economic activity in Canada has been proceeding as expected compared to its previous projections. However, the BoC still remains cautious:
• Government spending is expected to end during the year, but net exports still remain low. Net exports have been negatively affected by the rise of the Canadian dollar which closed on 1/17/2011 at 1.0126 USD. A high Canadian Loonie makes goods & services that are exported to other countries (especially the US) more expensive, and results in the nation being less competitive. Also contributing to the problem has been persistently low GDP (productivity). This has caused Canada’s current account deficit (trade gap) to continue widening to a 20 yr high.
• High household debt levels remain an issue. In December 2010, the Bank of Canada had already warned that household debt was at an unprecedented 144% of disposable income. It expects that this will “restrain the pace of consumption growth and residential investment”.
It expects that business investment will continue to improve, as a result of the current competitive financial conditions and economic policies. Overall, the Bank projects the economy will expand by 2.4 per cent in 2011 and 2.8 per cent in 2012. It expects the economy to return to full capacity and its CPI inflation target of 2% by the end of 2012.
Concerns Of Sovereign Debt Risk In Europe
Although European growth has also been slightly stronger than the bank anticipated, continued concerns of “sovereign debt and bank balance sheets” in Europe remain. Recently, the Euro Zone finance ministers have been especially concerned over Portugal, Spain, and Greece’s financial condition. The pace of the European recovery will be limited and and uncertain. This week, finance minsters in Europe met and discussed plans of a rescue fund, but agreed to move slowly.
Restrictive Policy Measures In Emerging Markets
The Bank of Canada has observed that commodity prices will be influenced by the effectiveness of “more restrictive policy measures” by emerging markets. Recently, China has continued to tighten their monetary policy. On 1/14/2011 China’s central bank raised lenders’ required reserves (for the fourth time in just over two months) to a record high reserve requirement ratio of 19.5% for China’s biggest banks. On 1/17/2011, it had cut the 2011 lending target for banks by 10%.
Increased US Demand
Private domestic demand in the United States has increased, and the bank expects it will be supported by the recent monetary and fiscal stimulus. In December 2010, US Federal Reserve chair Ben Bernanke indicated he was open to further quantitative beyond the $600 billion announced in November 2010.
Leaving Monetary Stimulus In Place
The bank again stated that maintaining the overnight rate “leaves considerable monetary stimulus in place”, “in an environment of significant excess supply in Canada”. It also reiterated that any further reduction in monetary stimulus would require careful consideration. This indicates that rates may be maintained for some time longer, as any increases would be detrimental to the Canadian economy and recovery at the present moment. However, we can expect rates to increase some time during the year.
Impact to investors & individuals
Rates are still very low in Canada, providing opportunity to secure relatively cheap credit (mortgages as well as other lines of credit). The 5 year fixed mortgages remain attractively low, although variable rates are not quite as attractive as they used to be (1- 2 years ago). However, tightening of credit has begun particularly in mortgage lending, as we expected. We can look forward to more credit tightening policies by the end of the year, even as rates to continue to stay relatively low for a bit longer. Lending rates will not rise significantly until the economy is strong enough to support it. If the pace of economy recovery becomes more healthy, then increases of 0.25% would not be unexpected. But a single increase would not have too much of an impact to borrowing costs or cash flow.
The Bank of Canada’s next scheduled date for announcing the overnight rate target is March 1, 2011.
Thanks and Happy Investing! – The Investment Blogger © 2011