BoC: Rate Unchanged, Economic Recovery Impaired by CAD Strength

The Bank of Canada kept the overnight rate unchanged at 0.25% and pledged to keep it at current level until the end of the second quarter of 2010 in order to achieve the inflation target. Concerning economic development, the central bank believed strong Canadian dollar will continue to dampen activities in Canada. In 2010, the growth driver will mainly come from domestic demand which relies on private sector.

At the accompanying statement, the BOC said that while economic recovery in underway in Canada, considerable excess supply remains, and the economy was operating about 3.25% below its production capacity in 4Q09. The central bank forecast that GDP will grow +2.9% in 2010 and +3.5% in 2011. These forecasts are compared with respective estimates of +3% and +3.3% growths made in October.

The BOC raised concerns about the negative impact of CAD’s strength on growth. ‘The factors shaping the recovery are largely unchanged - policy support, increased confidence, improving financial conditions, global growth, and higher terms of trade’. However, ‘the persistent strength of the Canadian dollar and the low absolute level of US demand continue to act as significant drags on economic activity in Canada’.

CAD rose +3% against USD since the last meeting. In 2009, the currency rallied +15% against USD. Strength in Canadian dollar should harm exports in the nation. Quoting the BOE’s comment, ‘these factors have shifted the composition of aggregate demand towards growth in domestic demand and away from net exports. The private sector should become the sole driver of domestic demand growth in 2011’.

We are not that confident about domestic demand growth without government’s support as job market remains weak and disposable income is low. Employment rate rose to a peak of 8.7% in August 2009. Although the rate fell to 8.5% in November and December, it’s still the highest levels in more than a decade. We believe both consumer spending and business investments will be cautious this year.