The BANK OF CANADA is expected to remain on hold over the summer, raising rates again in September, December and March 2012 – by 25 basis points each time. While economic growth is expected to accelerate (a spillover from accelerating US growth), domestic growth is likely to be only modest, with high consumer indebtedness and the recent tightening of mortgage regulations curbing domestic demand somewhat. Domestic credit growth has been flat (apart from home mortgages) and inflation has been lower than expected, notwithstanding fairly strong wage growth. Core inflation fell to just 0.9% in February, well below the Bank’s 2.0% target. The core rate is not expected to exceed 1.5% until near year-end. The Bank is likely to be wary of increasing interest rates before the Fed does as it could cause a further rise in the Canadian dollar, which would further dampen domestic growth prospects.
The FED Funds target rate is likely to remain in the 0% to 0.25% range for the remainder of this year, though the Fed may encourage a rise to the top of that range toward September whilst it contemplates the prospects for growth and employment, and inflation into 2012. At this point we have the Fed raising rates by 25 points in January and again
in April 2012. The Fed is expected to end its current round of quantitative easing as scheduled in June, even though the pace of economic growth is improving and is set to benefit further as a result of the 2011 payroll tax holiday and a new measure to allow much faster depreciation this year. Despite the improving growth picture, unemployment remains high and core inflation very low, although rising energy and food prices have already pushed headline CPI up to 2.1%.
The CANADIAN DOLLAR is expected to trend relatively flat, somewhat above parity, during the next six months or so, then move higher. While the Fed’s quantitative easing program could help boost commodity prices and the loonie further in the near term, a modest slowdown in emerging market economic growth is likely to serve as a counterweight. Mid-east unrest is a wild card. Extended political troubles in Libya and elsewhere could add to upward pressure on oil prices and also the loonie, whereas an early resolution could see oil prices and the Canadian dollar both fall. In any event, periodic commodity price corrections are expected in the first half of the forecast.
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