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The market is getting nervous again about the PIGS (Portugal, Ireland, Italy, Greece and Spain).
There are two issues here:
- First, while the EU has committed almost $1 trillion to help financing these countries, there is a big difference between promising money and delivering money. Note that the stock market in the US advanced by more than 10% after the introduction of the TARP, but the actual bottom in the market was achieved only four months after.
- Second, the market is starting to realize that austerity measures in the PIGS countries are essential, but the political ramifications are unknown. Implementing these austerity measures will slow down economic growth, which of course will reduce government revenues which, in turn, will make it more difficult to reduce the deficit.
No wonder the market is nervous.
But even a bigger story here is the growing realization that we are all PIGS. Yes the situation in Greece is an extreme case, but US debt is approaching levels that can make the IMF nervous. And in Canada, the government has accounted for no less than 40% of economic growth in the past decade. And as of the second half of the year this huge positive will turn into a negative.
- PIIGS growth 2005-2009
The practical implication here is that this recovery is going to slow materially in the second half of the year as government money becomes less available. It also means that with the government acting as a negative force for overall growth in the coming few years, the speed limit of the economy will be reduced.
An example for the non-liner nature of the recovery can be seen in today’s retail sales numbers in the US. While a number of categories such as autos, consumer products and gasoline did see gains on the month, the big driver of April’s aggregate sales performance was building materials. That category jumped an unusually large 6.9% (following a 7.8% increase in March), mainly due to the temporary home buyers’ tax credit which expired at the end of the month. And where is this money coming from? Most of the increase in personal income in the US is due to transfer payments from the government. This money will be less available in the second half of the year and in 2011.
There are clear signs that the US labour market is improving. Job creation in April was very impressive, and the weekly numbers of jobless claims continue to go down. However, a closer look suggests that we are still very far from a normally functioning labour market. The probability to finding a job if you are unemployed in the US is now 30%, up from 20% a few months ago, but still historically low. Weekly jobless claims are now at around 440,000, well below the 600,000 we saw in mid-2009, but still inconsistent with a market that is capable of creating 200,000 jobs a month on a consistent basis. And the number of people that are on either continuing claims or the Emergency Unemployment Compensation Program or Extended Benefits Programs is now over 10 million. The point here is that it will take a while until the labour market in the US gets back to normal.
There is no reason to believe at this point that the Bank of Canada will change its plans regarding rate hikes due to the situation in Greece. In fact, the market is currently discounting a 100% probability of a hike by June or July. But here again we think that the first wave of tightening will be limited due to the fact that the Fed will not be raising rates in 2010. But even beyond that, look for a relatively modest tightening cycle, given the significant negative impact of fiscal policy on overall growth in the coming years.
Benjamin Tal
Senior Economist
Canada’s economy produced a full month of better-than-expected economic data, helping to crank up inflationary pressure beyond expectations in February and put the Bank of Canada in the uncomfortable position of possibly breaking its pledge on interest rates.
Following the release of key inflation and retail sales data Friday from Statistics Canada, at least one Bay Street economics team revised upward its growth forecast for the first quarter by a full percentage point, and indicated more positive revisions could be in the offing.
The data, however, failed to power the Canadian dollar’s march to parity with its U.S. counterpart — although the loonie nonetheless made big gains Friday against the world’s other major currencies, as it set a three-decade high against the British pound and a 28-month high against the euro.
In all, Friday’s developments suggest the Canadian economy is roaring back at a pace that might be setting off warning bells at the Bank of Canada, which had conditionally pledged to keep its benchmark rate at 0.25 per cent until July to get the economy back on track.
“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,”
said Douglas Porter, deputy chief economist at BMO Capital Markets, which accordingly upgraded its first-quarter GDP forecast for Canada Friday to 4.7 per cent expansion, from its previous 3.7 per cent expectation.
Retail sales was the last piece of data to emerge from January, and with that Porter said Canada produced an “unbelievable” full month of better-than-anticipated economic data. For the record, retail sales jumped 0.7 per cent in January, above the 0.6 per cent consensus.
However, when autos are excluded, sales surged 1.8 per cent, or the biggest one-month gain since late 2007. This was due, in part, to a 7.4 per cent increase in sales at outdoor supply stores, as households rushed to buy building supplies before the one-time federal home renovation tax expired on Feb. 1.
Meanwhile, all eyes were on February inflation data, which proved to be equally robust, with the core rate — watched closely by the Bank of Canada — posting a surge beyond the key two per cent threshold.
Statistics Canada core inflation, which strips out volatile-priced items such as food and energy, advanced 2.1 per cent year-over-year in February, whereas analysts anticipated a 1.7 per cent year-over-year increase.
The Bank of Canada’s last economic outlook, tabled in January, envisaged core inflation to average 1.6 per cent in the first quarter and 1.7 per cent in the second quarter. The central bank’s pledge on rates was conditional on its inflation outlook unfolding as anticipated.
“The Bank of Canada has all the evidence it needs to convince itself it doesn’t need emergency policy measures anymore, I think (the data) tells you the economy is firing on a lot of cylinders.
I continue to believe the bank will wait until July but they must be getting incredibly uncomfortable with that long of a wait”
said Andrew Pyle, wealth adviser and markets commentator with ScotiaMcLeod.
The inflation data come with a caveat, as the Vancouver Olympics drove up prices in some key areas, notably travel and lodging. Nevertheless, Porter said inflation would still be above the central bank’s forecast even if the Olympic-related numbers were adjusted.
Mark Carney, the Bank of Canada governor, might shed further light on the central bank’s outlook in a speech in Ottawa this coming Wednesday.
There was anticipation that robust inflation data could finally propel the loonie to parity with the U.S. dollar. That was not the case, however, as traders cashed in on profits and sought safety in U.S. dollars, largely due to uncertainty as to how the eurozone would deal with Greek debt problems, and an unexpected rate hike in India. The dollar closed Friday at 98.39 cents U.S., down slightly from the previous session.
“The market remains unwilling to take the final plunge (toward parity) without the support of improving global sentiment,” said Matthew Strauss, senior currency strategists at RBC Capital Markets.
Source:
edmontonjournal.com
Financial markets tend to get edgy sitting still, but Bank of Canada Governor Carney is a man in no hurry to act. Drawing a parallel with Australia, where a rate hike came earlier than expected, investors had been pushing up Canadian short-term yields in anticipation that Canada would also raise rates. Of course, when fixed income investors start to expect an earlier rate hike, that exerts upward pressure on the dollar which makes such a move less likely. Therefore, the Bank’s message to those expecting an early rate hike in Canada was “not so fast”.
Clearly, the Bank takes currency impacts on growth and inflation very seriously. After citing a list of fresh positives—including better-than-expected global growth and improvements in financial market conditions—the Bank asserted that these will be “more than offset” by the drag from persistent Canadian dollar strength.
The Bank reinforced its pledge to keep rates on hold.
So, in its most recent interest rate announcement, the Bank reinforced its pledge to keep rates on hold at least until after June of 2010. Since the timing of rate moves is geared to the timing of getting inflation back to the 2% target, if anything, the Bank may even add a few months to when it anticipates pulling the trigger on the first rate hike.
While CIBC World Markets is roughly in line with the Bank of Canada’s growth projection for the balance of this year, we’re not as optimistic about Canada’s ability to shrug off a likely slowing in US growth in 2010. If we’re right, it will take even longer than the Bank’s forecast to get back to full employment and target inflation. Therefore, if the US keeps rates on hold throughout 2010, it’ll be difficult for the Bank of Canada to move first, as long as the Canadian dollar is near parity.
No need for structural change in the mortgage market
Mark Carney, Bank of Canada governor, said on Thursday he does not see a housing bubble currently, nor does it see the need for structural change in the country’s mortgage market.
He was responding to audience questions after a speech in Winnipeg where he said that the Canadian economy is looking up and should recover lost ground this year.
“The Canadian mortgage market has functioned I think exceptionally well during the course of the last decade … we’ve seen the strength of the system of mortgage insurance and it’s provided an important funding avenue for the banks as well. It’s allowed our housing market to weather the storm,”
“I must say we don’t see a need for structural change in the mortgage market.”
Carney also said he would not describe current housing market strength as a housing bubble.
“We had expected strength in the housing market given where monetary policy was. We’ve seen it. We are following it closely but we would not characterize the current state of the housing market in those terms.”
Carney said the central bank continues to be concerned about the pace of household borrowing, a point he has been driving home to Canadians to prepare them for eventual rate hikes.
“We want to caution people that rates are extraordinarily low right now, they’re low for a reason … but it’s a means to an end.”
The central bank pledged last April to keep interest rates at record lows until the end of June 2010, a pledge it has since reiterated with each successive interest rate decision and speech by bank officials.
- You can Download the entire speech in PDF format.
- Audio webcasts of the speech and the press conference are accessible from this location:
http://www.bankofcanada.ca/en/real/