Will Mortgage Rates Begin To Climb?

Virginia Galt Globe and Mail Tuesday October 20, 2009

The Bank of Canada left its benchmark interest rate at a record low 0.25 per cent Tuesday, stating that while the Canadian economy is recovering, the current strength of the Canadian dollar “is expected, over time, to more than fully offset the favourable developments since July.”

Here's what the analysts had to stay after parsing the bank's statement:

“Financial markets tend to get edgy sitting still, but Bank of Canada Governor Carney is a man in no hurry to act,”

Avery Shenfeld, chief economist at Canadian Imperial Bank of Canada, said in a research note.

“Drawing a parallel with Australia, where a rate hike came earlier than expected, investors have recently been pushing up Canadian short-term yields in anticipation that Canada wouldn't be far behind. To those expecting an early rate

hike in Canada, the bank's message was ‘not so fast.'

“After citing a list of fresh positives – including better-than-expected global growth and improvements in financial market conditions – the Bank asserts that these will be ‘more than offset' by the drag from persistent Canadian dollar

strength,” Mr. Shenfeld said.

“For the near term, before the currency impacts have had a chance to bite, the bank has ‘slightly' raised its 2009 second half forecast,” Mr. Shenfeld said. “Hitting its -2.4 per cent real GDP [gross domestic product] forecast for 2009 as a whole implies that the bank's forecast for fourth quarter growth must be close to 4 per cent.”

Investment adviser Andrew Pyle of ScotiaMcLeod said the Bank of Canada employed some of “its toughest language” in warning about the threat to economic growth posed by the high level of the Canadian dollar.

Mr. Pyle said the bank's comments tell us two things:

“The Bank is serious about the implications of a further rise in the loonie to above parity [and] it is not going to pull an Australia and raise interest rates prematurely.”

Some of the loonie's recent appreciation has been attributed to speculation that the Bank of Canada would follow the lead of the Reserve Bank of Australia and raise its benchmark interest rate sooner than originally planned. However, on Tuesday, the bank repeated its conditional commitment to keep the rate at 0.25 per cent until well into next year.

“Now if we were to see sustained momentum in the U.S. economy, from the domestic sector, then the bank might ease off on this stance, but so far we're not seeing signs of that,” Mr. Pyle said in a research note.

“The U.S, is getting pumped off exports and inventories this half, while Canada is left to get its growth from

consumers and builders. This combination cannot persist forever, especially if the loonie goes back and retests the highs of November, 2007 [when it hit a peak of $1.10 U.S.]”

“The Bank of Canada has clearly dealt a blow to the near-term rate-hike camp, recommitting to leave the overnight rate unchanged through mid-2010,” economist Eric Lascelles of TD Securities Inc., said.

“The strong housing market barely attracted a mention, while rhetoric about the damage of Canadian dollar strength was ramped up substantially. The Bank of Canada now believes the economy will not return to full capacity until the third quarter of 2011 instead of the prior view of the second quarter of 2011,” he said.

“As with previous decisions, the bank argues that it maintains ‘considerable flexibility' in its conduct of monetary policy, though we do not expect any lengthening of the conditional commitment [on interest rates] or shift into quantitative easing this the juncture.”

Quantitative easing effectively dilutes the value of a currency by increasing money supply.

The Canadian dollar was down 1.70 cents to 95.45 cents (U.S.) by midmorning after the Bank of Canada' rate announcement.

“Markets shouldn't have been surprised in this manner,” economists Derek Holt and Karen Cordes of Scotia Capital said in a research note.

“We remain of the view that the global market tendency to blindly lump Canada with the Reserve Bank of Australia's dynamics …was ill-advised, given the night-and-day differences in the Canadian economy's export exposures and currency sensitivities,” the Scotia Capital team wrote.

“Canada's exports are hitched to the weak U.S. economy versus Australia's exports to China, and Canada has among the higher degrees of import content to domestic economic activity of many industrialized economies, which mutes inflationary pressures via an elevated Canadian dollar.”

Look to the Bank of Canada's quarterly monetary policy report, to be released Thursday, for more detail on the Bank of Canada's economic outlook and its policy options, economist Michael Gregory of BMO Nesbitt Burns said.

Market-watchers were not expecting any more concrete action – beyond tough talk – to dampen the level of the loonie.

“There was no concrete action on the Canadian dollar, but the Bank of Canada jawboned its concerns more aggressively than in the last statement,” the Scotia Capital economists noted Tuesday.

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