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News Article-Interest rates on the rise this Summer?

Courtesy of Vancouver Sun
By Scott Simpson

Higher-than-expected inflation, a robust dollar and a strengthening economy strongly suggest that the Bank of Canada will begin to raise interest rates as early as June, analysts said Friday.

Statistics Canada reported higher-than-expected year-over-year core inflation of 2.1 per cent for February.

Analysts said that trend, along with solid employment growth and robust consumer sales in January, could emerge as a primary motive for the bank to unfreeze its "emergency" 0.25-per-cent prime lending rate, even though February inflation was substantially skewed by a 16-per-cent increase in travel accommodation in Vancouver during the Olympics.

Consumer prices rose 1.6 per cent year-over-year in February, exceeding market expectations of a 1.4-percent increase. Retail sales were up 0.7 per cent. Excluding automobiles, the increase was 1.8 per cent, or triple the expected amount.

BMO Capital Markets updated its first-quarter GDP growth forecast to 4.7 per cent on an annualized basis, up from a forecast 3.7 per cent.

"There is simply no mistaking that growth and inflation have more underlying power than even the most strident optimist would have believed just a few short months ago," BMO Capital Markets deputy chief economist Doug Porter said in a commentary.

Porter observed that "the string of robust economic readings added further fuel" to the Canadian dollar's recent gains against the U.S. dollar.

Porter noted that the U.S. Federal Reserve appears to be in no rush to raise expectations of a similar interest rate hike in the near term.

CMC Markets chief currency analyst Ashraf Laidi noted in an interview that, compared to a jump last October in the value of the Canadian dollar relative to U.S. currency, the reaction this time from Bank of Canada officials and federal Finance Minister Jim Flaherty is relatively muted.

"Before, they did not miss a beat whenever the Canadian dollar would appreciate significantly. They would come in and they would try to talk it down," Laidi said. "Now, the Bank of Canada in its monetary policy pronouncement does have a word or a phrase about the dampening impact of the rising dollar, but they do not do anything about it."

That likely means Canada is prepared to allow its dollar to hover around parity with its U.S. counterpart, and that the government believes that situation is justified by the economic data, he said.

Laidi agrees with their assessment.

"There are obvious reasons why the Canadian dollar is going up," said Laidi, the U.K.-based author of an acclaimed book on foreign exchange finance, Currency Trading and Intermarket Analysis, and an international commentator on relative currency valuations.

"It's the robustness of oil, it's the internally generated demand, the unambiguous improvement in the labour market in Canada.

"All of these obviously lead to the equation that the Bank of Canada will be expected to raise rates, and you are seeing relatively muted reaction from the monetary Canadian officials regarding the excessive depreciation of the dollar."

The dollar's rise also correlates with recent strength in North American stock markets, he said.

"It has been a very good correlation between them. Today, for example, as we are speaking, you are seeing the S&P retreating and you saw the Canadian dollar retreating against the U.S. dollar after almost hitting parity."

The Canadian dollar fell about a quarter of a cent lower against the U.S. dollar on Friday to close at 98.39 cents US.

Laidi said the Canadian dollar belongs to a group of currencies favoured by traders who associate it with the underlying commodities that represent the foundation of the nations' economies, including oil, metals and minerals.

That group of currencies, which includes the Australian and New Zealand dollars and the Norwegian krone, attract currency traders including hedge funds, which perceive it as offering higher yields, or interest rates, than U.S. dollars and Japanese yen.

"One of the reasons the loonie was really pushed up was one or two months ago, when the Bank of Canada in its monetary policy statement hinted at discontinuing these emergency liquidity measures that are aimed at increasing liquidity in the money market, the bond market, and restoring confidence," Laidi said.

"The moment it removes the hint from its policy statement the currency market said, 'That's it, they are paving the way for a potential rate hike.' Currency markets don't have to wait for the rate hike to materialize. "They are given a signal and then they are going to start to buy in anticipation."