Weekly Bank Research Center 5-21-07
Bank of Canada Hike on Potential
Stephen Roach, Head Economist, Morgan Stanley
Canadian growth has remained broadly in line with the Bank of Canada expectations so far this year. However, core inflation has remained sticky at levels higher than the BoC expected. To explain the situation, the BoC revised its view of the economy, citing that it is now running a small excess demand due to slower potential growth. In this note, we look more closely at the reason why potential output is lower and outline the risk that slower labour productivity growth in the near future will lead to a longer period of excess demand and, therefore, a prolonged period of higher-than-target inflation. In this context, the BoC will have to hike rates later this year, most likely in 3Q, to bring the economy into balance. This would provide further support for the CAD. We currently hold a short GBP/CAD position in our model portfolio.
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Dip in Eurozone GDP Growth is Temporary
[/B] [/B] Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Euroland GDP growth slowed slightly to 0.6% q/q in Q1, down from 0.8% q/q in Q4. However, this lower rate of growth was expected, due primarily to the German VAT increase, a drop in net exports, and lower in-dustrial output in Italy. These factors are probably temporary, and the stage is set for a return to growth slightly above trend in Q2. We predict growth of 0.8% q/q in Q2, corresponding to annualised growth of around 3.5%. We also antici-pate continued healthy growth above trend in H2, which will pull unemployment in Euroland down further. There is, therefore, much to support our view that the ECB will continue to raise interest rates in H2, al-though the monetary policy path is now more uncertain . we have seen falling credit growth and tighter fi-nancing conditions from not only higher short-term interest rates but also a stronger EUR.
[B] [B][B][B] [B] US and Canadian Interest Rates to Converge
[/B] [/B] Steve Chan, Economist, TD Bank Financial Group
Recent developments have led us to revisit our outlook for monetary policy in Canada and the United States. For quite some time we spoke of the upside risks to Canadian inflation posed by an economy increasingly straying into a position of excess demand. We now see that those risks have materialized, and as a result, we have shortened the horizon for our expectation of a 25 basis point hike to July’s Fixed Announcement Date (FAD) and have added a second 25 basis point hike for the September FAD. All told, this will bring the overnight lending rate to 4.75%, at which point we anticipate the Bank will remain on hold through the end of 2008. We also expect the opposite action to occur in the United States, where the combination of cooling inflation and soft real GDP growth will allow the Federal Reserve to cut their key lending rate by 50 basis points over the final three months of the year. This will lower the Fed funds rate to 4.75%, bringing North American policy rates into convergence for the first time since early 2005.
[B] [B][B][B] [B] Other Pre-screened Independent Contributors[/B]
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