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Expect a big rate cut soon

Blog by Shaun Kimmins | December 8th, 2008

OTTAWA - A steeper-than-expected retreat in housing construction last month should give the Bank of Canada one more reason to cut rates sharply early Tuesday - not that it needs one.

However, the disappointing economic news was ignored by investors who sent stock markets here and around the globe soaring on expectations of an auto-industry bailout and massive economic stimulus package by U.S. president-elect Barack Obama's incoming administration.

The annual pace of housing construction starts plunged by a more-than-expected 40,000 units to 172,000 in November, leaving residential construction so far this year down nearly eight per cent from the same period last year, Canada Mortgage and Housing Corp. reported Monday.

Further, the Organization for Economic Co-operation and Development reported that Canada's jobless rate, at 6.3 per cent in November, had moved above the 6.2 per cent average for all industrial countries, although that is still below 6.7 per cent in the U.S.

"As has been the trend of late, the market is however completely ignoring the data and is electing to trade off of larger, more global themes, at least as it pertains to equities and currencies," noted Mark Frey, vice-president of foreign exchange at Custom House, an international payments firm.

Obama's commitment to what is being described as the largest U.S. federal infrastructure package since the building of the interstate highway system in the 1950s bolstered hopes for a recovery from that economy's year-long recession and, in turn, in the global economy and commodity prices.

"Word from president-elect Obama that he will seek to spend his way out of the global recession without regard for budgetary deficits, and renewed hope that a deal will get done for the Big Three U.S. automakers, has traders in a deal-making mood," Frey observed. "Not only has the risk aversion that has captivated markets for the better part of the last two weeks been outcast today, full-fledged risk acceptance is now on display as equities rally, yields continued lower and the U.S. dollar is in full retreat against everything but the Japanese yen."

"But the U.S. was not the only country going stimulus-crazy," TD Securities said in an analysis, noting that authorities in the world's two largest emerging economies - China and India - also announced monetary and fiscal stimulus measures to boost their economies.

The announcements were followed by stock market rallies in Asia, Europe and North America. Canada's resource-heavy benchmark index, the S&P/TSX composite, soared 450 points, or more than five per cent, to 8,567 and Wall Street's blue-chip Dow Jones industrial average nearly 300 points to 8,934.

However, last week's news of stunning job losses on both sides of the border - 71,000 in Canada and a further 533,000 in the U.S., which brought losses there to nearly 1.9 million since the recession began a year ago - underscored the seriousness of the North American economic slump and what analysts said was a need for further interest-rate and fiscal stimulus here and south of the border.

In Canada, the need for lower rates was reinforced by the steepness of the drop in housing starts and a warning by the federal housing agency that the weakness will continue though 2009.

Analysts expect that, in light of evidence of a sharper-than-expected deterioration in the Canadian economy and with any new major economic stimulus package from the Canadian government still six weeks away, the Bank of Canada will cut interest rates early Tuesday (6 a.m. Pacific time) by at least half a percentage point, and possibly more. The central bank's key lending rate now stands at 2.25 per cent.

"The Bank of Canada has recently highlighted three key risks to the Canadian economy: the weakness in the U.S., slumping commodity prices and little measurable improvement in credit conditions," noted Charmaine Buskas, an analyst at TD Securities, which expects a half-point cut in bank's trendsetting rate. "None of these factors have posted any improvement and, in fact, continue to worsen."

Evidence of the continuing credit crunch was an announcement by the Bank of Canada that it will, as previously scheduled, inject up to $10 billion more of liquidity into domestic credit markets on Tuesday.

"The bank will continue to provide additional term liquidity as long as conditions in financial markets warrant," the bank also noted.

Finance Minister Jim Flaherty indicated Monday that the federal government may agree to a request by the Canadian subsidiaries of the Big Three automakers for $6 billion in federal and provincial aid, but suggested it would be conditional on concessions by both the automakers and their unions.

Meanwhile, Flaherty defended the Conservative government's delay in announcing any new measures to stimulate the economy until at least the Jan. 27 budget, arguing that measures in his previous two budgets, including further business tax cuts that kick in the new year, are continuing to provide stimulus.

"We have already stimulated the Canadian economy," he told reporters in Toronto. "We are stimulating as we speak. There are three new tax provisions that come into force in less than 30 days in this country. We have doubled infrastructure spending in this country. There's lots of stimulus here."

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