Bank of Canada outlook: rates expected to remain unchanged

Bank of Canada: interest rate decision (Tuesday 19) – During next week’s monetary policy meeting, the Bank of Canada is widely expected to leave rates unchanged at 0.25%. We also estimate that the BoC will confirm its view that rates should be held steady until the end of Q2 ’10. The Canadian economy showed signs of picking up in Q4 (latest data on employment, retail sales and housing activity came in better than expected) strengthening the view that economic activity will gather momentum in early 2010. The Consumer Price Index is expected to show volatility in commodity prices, but overall inflationary pressures should remain subdued as the output gap will not close before the end of the year. With inflationary pressures subdued and the Canadian Dollar strengthening against the US Dollar, we see the possibility that the BoC will maintain rates longer than projected by the Bank and longer than our interest rate rule would prescribe. Indeed, we believe that unless there is a weakening of the Canadian Dollar, which is overvalued by almost 15%, the BoC is unlikely to tighten monetary policy ahead of the Fed (we predict the Fed will not raise rates before H2 ’10). However, our interest rate rules indicate that, should economic recovery be stronger than expected or inflationary pressures less subdued than forecasted, the BoC has the possibility to hike rates considerably (e.g. to 2%) before the end of 2010. In this case the Canadian Dollar may strengthen considerably against other major international currencies, mainly against the US Dollar.