Monday, May 31, 2010

Bank of Canada in the spotlight

The Bank of Canada will announce its interest rate decision tomorrow. Most economists believe that Bank of Canada governor Mark Carney will increase the benchmark overnight rate by 0.25%, which brings the rate to 0.5%.

Ever since economists started to debate about when Canada and the US will increase their interest rates, my forecast has been September for Canada and Dec 2010/Jan 2011 for the US. However, rosy economic data have emerged from Canada one after another, with the most recent being today's news that the Canadian economy grew at an annualized rate of 6.1% in the first quarter. In fact, by April, the rosy economic numbers basically guaranteed a rate hike on June 1.

However, the debt crisis in Europe then occurred, which devastated stock markets, and threatened to plunge countries back into recession. This threw into doubt a rate hike on June 1, which was previously all but certain.

Today, there are two camps on what the Bank of Canada should do. One camp is for a rate hike on June 1, and their biggest argument is the rosy economic data. For example, fourth quarter GDP rose by 4.9%, while first quarter GDP grew by 6.1%. The second camp is for a rate hike in July. Their main argument is that the debt crisis in Europe and the high unemployment in the US will slow Canada's economic growth. This would occur through lower Canadian exports and less foreign investments in Canada.

Regardless, if Mark Carney raises the interest rate by 0.25% tomorrow, I do not expect an impact on the TSX. This is because consensus is expecting a June 1st rate increase, and the rate hike has already been priced in. The main factor determining the direction of the stock market is going to be Europe (and particularly Spain) for the next few weeks.

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