Canada's Housing Bubble

Oct 09, 2010 Paul Vieira Financial Post

Ottawa -- Economists at Bank of Nova Scotia said Friday they expect Canada’s central bank to refrain from interest rate hikes until September of next year, as additional liquidity injections by its peers in advanced economies and slower U.S. growth would “handicap” the Bank of Canada’s flexibility.

In a note to clients, Derek Holt and Gorica Djeric said it anticipates the Bank of Canada’s benchmark rate to end 2011 at 1.75%, or just 75 basis points above its present level.

The Scotiabank economists say the prospect or reality of central bank-led asset purchases, or so-called quantitative easing, in Japan, the United States, England and the European Union would keep the Bank of Canada on the sidelines.

The thinking is traders will move their cash out of currencies like the U.S. dollar and the yen, and into countries where further easing is unlikely, such as Canada. This would force up the value of the Canadian dollar, making it more difficult for companies to sell their goods abroad and keep a lid on inflation, which drives Bank of Canada rate decision.

Also compounding matters is the so-called currency war among Group of 20 countries, as they try to curb appreciation in their currencies in an effort to make their exports more competitive.

Mark Carney, the Bank of Canada, has warned there are “limits to the divergence” between Canadian and U.S. monetary policy.

“Our overriding theme for Canada is one of how the global push toward a further round of quantitative easing and downsides to U.S. growth prospects force the Bank of Canada’s hand away from continued rate hikes,” the Scotiabank economists said.

They warned, however, this may further aggravate conditions dealing with household debt, which is at record levels. “A prolonged pause may well ultimately compound Bank of Canada exit challenges through forces conspiring to keep short- and longer-rates too low for too long, thus explaining [Mr.] Carney’s increased emphasis upon trying to jawbone Canadian households to feed slower growth in debt positions.”

The Bank of Canada’s next rate decision is on Oct. 19, and traders have virtually priced in little chance of a rate hike then. The next day, the central bank releases its updated economic outlook, which is expected to revise down GDP expansion in the third and fourth quarters of this year.

Financial Post