Investors Bullish on Canadian Loonie Despite Record Interest Rate Cut

Today, the Bank of Canada followed up on an earlier promise by formally clarifying its position on quantitative easing. Suffice to say that the markets breathed a huge sigh of relief when it was revealed that the BOC was not committing itself to such a program. ” ‘The market has always had great trepidation about the idea of printing money…As the Bank of Canada has pushed back at that notion, the Canadian dollar is having a little party of its own,’ ” quipped one analyst.

In other words, the BOC would like to avoid following in the footsteps of its counterparts in the US, UK, Japan, and perhaps the EU, by pumping newly-minted money directly into credit and government bind markets. At the same time, the Bank admitted that a rapid deterioration in the Canadian economy would certainly prompt it to reconsider. Governor Mark Carney et al have approached the subject of quantitative easing coyly. On the one hand, today’s report (as well as the BOC website) contain detailed explanations of what quantitative easing would hypothetically entail. On the other hand, they insist that such a scenario does not fit with their economic projections, and hence remains unlikely. “The need to do extraordinary easing is a ‘big if,’ ” in the words of Governor Carney.
This is largely consistent with analysts’ expectations, one of whom had predicted that “it’s also quite possible the bank could simply lay out a framework on Thursday and not take any action at all.” Even ignoring the inflationary implications of quantitative easing, it’s not clear whether such a policy could even be effective. “The corporate bond market is reviving, with spreads narrowing and issuance levels improving, raising the question of whether central bank involvement is necessary or appropriate in a market that seems to be healing itself.” Granted, most investors are now wearing their rose-tinted glasses, but the data speaks for itself.
The BOC’s estimation that it can avoid quantitative easing is somewhat dubious, since it is predicated on overly optimistic economic forecasts, as well as because it has already exhausted the primary tool in its monetary arsenal. Earlier this week, it lowered interested rates to a record low of .25%, capping a 16-month period of easing, during which it slashed rates by 4.25%. By the Bank’s own reckoning, interest rates will remain low until mid-2010, as inflation is now comfortably within the target range of 1-3%.
Given the abysmal economic situation, it is no surprise that inflation has moderated. Commodity prices are well below the record highs of 2008. Aggregate demand, and GDP by extension, are retreating in kind. According to one economist, ” ‘When you do that math, no matter how optimistic you are, you are talking about a time frame of years before things like the unemployment rate (are) back down to historically normal levels.’ ”
Still, traders remain bullish on the Loonie. “Since March 9, the loonie has climbed 6.2 percent…The loonie will appreciate to C$1.19 by the end of March next year, according to the median forecast of 38 economists and analysts in a Bloomberg survey.” As the Forex Blog reported in yesterday’s post, the carry trade has returned, which is good news for commodity currencies, low interest rates are not. Meanwhile, low interest rates could stimulate corporate borrowing and home buying. Given the Central Bank’s reluctance to print money, the economic recovery would even unfold without the drag of inflation. Maybe the excitement is justified…