BOC Stops Short Of Q.E. For Now

The Canadian economy has weakened at its fastest pace since the 1990 recession with real GDP falling 3.4% in Q4 2008. January 2009 GDP declined by 0.7%. Canada's unemployment rate hit its highest level in seven years at 8% and Canada's trade surplus turned to deficit in January. Canada's year-end inflation rate fell to 1.2% from 1.4% in February. In response to weakening Canadian economy and falling inflation, the Canadian government announced a $C 40 billion stimulus plan at the end of January and the Bank of Canada cut interest rates to a record low 0.25% Tuesday. The BOC has lowered rates 4.25% basis points since December 2007. Canada's PM Harper says his government will take additional fiscal measures if it's necessary to boost the economy and that he is watching the jobless numbers closely. In addition to BOC rate cuts and Canadian fiscal stimulus there has been speculation that BOC may adopt quantitative ease to boost growth. Thursday the BOC released its Monetary Policy Report (MPR) which outlined the framework for unconventional policy measures. The BOC stopped short of implementation of quantitative ease and CAD rallied.

According to the MPR, The Bank of Canada expects the Canadian economy to contract by 3% in 2009 with the economy gradually recovering in Q4 2009. The BOC expects Canada's economy to expand by 2.5% in 2010 and 4.7% in 2011. According to the Bank of Canada, Canadian inflation will continue to weaken in 2009 and return to 2% target in Q3 2010. Canada's Finance Minister Flaherty said the revised BOC growth forecast did not warrant the need for new stimulus. The BOC said that interest rate policy will remain on hold through end of the year contingent upon inflation outlook.

Here are some of the reasons why the BOC elected not to adopt quantitative ease at this time. The Canadian fiscal and financial market situation is better than most of the G-7 .Canadian government officials and the BOC expect the Canadian economy to rebound faster than its counterparts. In addition, Canadian officials expect past rate cuts and fiscal stimulus to boost the economy in the second half of 2009 .Canada's Finance Minister Flaherty says he sees signs of improvement in Canada's bond and capital markets along with signs recovery in the US and Canada. There are signs that the Canadian economy is stabilizing as Canada posted a small trade surplus in February as exports rise and retail sales posted an unexpected 0.2% rise in a February. Flaherty suggests that deflation is not a threat in Canada at this time but the risk of inflation could re-emerge if the recession worsens. Canadian credit market conditions remain tight but have improved since the fourth quarter of 2009. BOC rate cuts have been passed long by commercial banks which should help boost domestic demand. The BOC says that the synchronized global recession means that monetary and fiscal policies will take longer to have impact. The BOC has elected to take a wait and see approach before deciding to adopt unconventional monetary policy measures.

The BOC Monetary Policy Report outlines what additional actions that BOC is considering to boost growth and if needed to implement quantitative ease. The BOC said it could use quantitative easing and purchase financial assets expanding of the money supply. The BOC could buy private sector assets to help ease credit and the BOC can make statements about interest policy to influence interest rate expectations. The BOC stopped short of joining the Bank of England and Fed and implement quantitative ease now. The BOC decision to not implement quantitative ease at this time is a vote of confidence by BOC that the actions taken so far will lead to the economic recovery. The fact that the BOC stopped short of implementing quantitative is a mild positive for CAD. If the BOC is correct and the Canadian economy is on the path to recovery the CAD should appreciate. The risk to this outlook is if the Canadian economy continues to weaken, the Bank of Canada has left the door open to adopt quantitative ease.

USD/CAD traded as high as 1.3066 in March pressured by deteriorating Canadian economic outlook, rising risk aversion and speculation the BOC would continue to lower rates and adopt quantitative ease. USD/CAD traded to 1.2075 on April 17th supported by a rebound in equities, improving risk sentiment and commodities prices. CAD is currently trading at 1.2200 -1.2600 range. Fresh break of the April 17th low could spark a move of to 1.1600. The preferred strategy is to sell USD/CAD on allies to 1.2500.

By Michael J. Malpede

Easy Forex
http://www.easy-forex.com

Michael J. Malpede is Chief Market Analyst with Easy-Forex® and has previously been featured on Bloomberg TV, Bloomberg radio, Reuters, MarketWatch, Wall Street Journal, Chicago Tribune, Chicago Sun Times, Toronto Star and Nikkei press. In analyzing the markets, he draws from 29 years of Foreign Exchange Research as a Foreign Exchange Analyst.

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