Wednesday, March 9, 2011

Economy Growing Faster than expected

OTTAWA — The Bank of Canada said Tuesday the economy is growing at a “slightly” faster pace than expected as signs emerge of a recovery in exports, but gave no hint it was ready to resume hiking interest rates.

As expected, the central bank kept its benchmark rate unchanged at 1%. And in a five-paragraph statement, it struck what analysts deemed a cautious tone in an effort to dampen enthusiasm after Statistics Canada reported the economy grew at a 3.3% annualized clip in the fourth quarter — or a full percentage point above the central bank’s forecast. This prompted yields to climb and the loonie to head upward on anticipation of earlier-than-expected rate increase.

The dollar lost ground following the rate announcement, trading in the US$1.0268 range as of 10:15 am ET, down from as high as US$1.0309 on Tuesday.

“There are no indications here that rate hikes are close,” said Michael Gregory, senior economist at BMO Capital Markets. “We judge that the bank is waiting for evidence that U.S. economic performance is strong and steady enough to ensure that Canadian exports will contribute to Canadian economic growth regardless of the level of the loonie.”

As it happened, a key gauge of U.S. manufacturing activity rose in February to its highest level since May 2004, data showed Tuesday.

The Bank of Canada said there are signs a transition is underway, from an economy powered mostly by consumers to business investment and exports.

“The recovery in Canada is proceeding slightly faster than expected,” the central bank, led by governor Mark Carney, said, “and there is more evidence of the anticipated rebalancing of demand.”

In its last rate decision on Jan. 18, the central bank said economic recovery in Canada was headed for a period of “more modest growth,” with 2.4% expansion expected in 2011. At the time, Mr. Carney said the country would be hard pressed to “fully benefit” from an upswing in U.S. prospects due to a lack of competitiveness. But the 2011 outlook is near the low end of expectations compared with private-sector economists, who upgraded their forecasts further after the release of fourth-quarter GDP data.

The statement “did not indicate any significant shift in sentiment regarding Canada's economic outlook,” said Dawn Desjardins, assistant chief economist at Royal Bank of Canada.

“The fact that the economy showed stronger than expected momentum in the second half of 2010 did not seem to impress policymakers.”

The central bank said domestic demand continues to expand although household spending is “moving” in line with growth in disposable income; business investment continues to “expand rapidly” as companies take advantage of low interest rates and the need to boost competitiveness; and an anticipated comeback by the trade-oriented sector appears to be unfolding.

“There is early evidence of a recovery in net exports, supported by stronger U.S. activity and global demand for commodities,” it said, although warning: “The export sector continues to face considerable challenges from the cumulative effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance.”

Prior to the rate statement’s release, the Canadian dollar touched another 40-month high, as the loonie hit US$1.0309, up from Monday’s close in the US$1.029 range. The Canadian currency shot upward after the release of the GDP data, on the anticipation the Bank of Canada may begin raising rates earlier than previously believed.

Traders have priced in 100% odds of a rate hike in July, once the U.S. Federal Reserve completes its US$600-billion asset-purchase plan. But some analysts say the GDP report tilts the balance back in favour of an interest rate increase in May.

The Canadian dollar rise is powered by the country’s relatively sterling fiscal fundamentals, economic prospects, and a rise in commodity prices -- highlighted by oil prices cracking the US$100 a barrel level last week on concern about Libya.

In the rate statement, the central bank said robust demand from emerging economies is driving the strength in commodity prices, “which could be further reinforced temporarily by supply shocks arising from recent geopolitical events.” That was the only reference to the potential risks posed by a growing wave of protests across north Africa and the Middle East.

Global inflation pressures are rising due to higher energy and food costs. But in Canada, the central bank said inflation is in line with its expectations – the core rate, which strips out volatile-priced items, stood at 1.4% in January – and pricing pressures remain subdued, reflecting “considerable slack” in the economy.

Paul Vieira, Financial Post · Tuesday, Mar. 1, 2011

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