Bank of Canada (Probably) Ends Tightening Cycle

On the "it's time to hold" side, there is a concern that the U.S. and Canadian economies will weaken fairly sharply in the second half of this year. There are definite signs the housing market, especially in the United States, is beginning to pull economic growth downward. The Canadian dollar was on a surge over April, hitting a thirty-year high in early May. Some of this recent rise to the 90-cent level can be attributed to a general weakness in the U.S. dollar. It is this type of appreciation that the Bank will respond to with monetary conditions weaker than otherwise. There are strong signs in recent trade statistics and surveys that Canadian exporters are in need of relief from the high and rapidly rising loonie. Inflation is generally under control, with the core rate being consistently stable below the 2% level in recent months. Rising gasoline prices have been the cause of the over-all CPI's rise above 2% in recent months.

Today's increase was anticipated in recent Global Insight forecasts. The Bank's language in today's announcement does indicate that they are now likely prepared to take a breather to monitor conditions for several months at least, before moving rates from today's level. In Global Insight's view, this seven-step tightening cycle has probably come to an end, and the Bank will hold at least until the fall. It is important to note that the Bank's forecast for Canada's growth for next year, at 3.0%, is slightly stronger than the consensus. There is, therefore, a distinct possibility that by the fall, growth may appear weaker for next year, than what the Bank is forecasting. If next fall, the Canadian dollar has remained above the 90-cent level—and it is expected to do so for some time, primarily due to a weaker U.S. dollar as opposed to stronger commodity prices—and/or if there are definite signs the U.S. economy is heading into several quarters of weak growth, then the Bank may begin to move rates downward. However, rates are now in what could be regarded as "neutral" territory: a rate consistent with 2% inflation. Therefore, it will take some fairly convincing evidence before the Bank will move rates from today's level.