Bets on Carney Rate Increase Scrapped as Canada Recovery Slows

Investors have erased bets for Bank of Canada rate increases through July after a report suggested the economic recovery will take longer than Governor Mark Carney predicts.

Trading in overnight index swaps on Sept. 28 showed that interest rate increases had been almost completely priced out for the July 2013 decision, compared with 4.4 points of increases the day before and 17 points of rises on Sept. 19.

Carney is the only Group of Seven central banker signaling a bias to raise interest rates because he forecasts the world’s 11th-largest economy will reach full output in the second half of next year. Canada’s economy grew 0.2 percent in July, according to a Sept. 28 Statistics Canada report, suggesting annualized third-quarter growth will be slower than the 2 percent the central bank predicted.

“The Governor has been clear we need to see an acceleration in growth to something above potential to justify a rate hike,” said Canadian Imperial Bank of Commerce Chief Economist Avery Shenfeld, who predicts no move until early 2014. “The economy is cruising but not fast enough to reach its speed limit.”

The economy will grow by 2.1 percent in 2013, according to Bloomberg economist forecasts, slower than the central bank’s forecast growth of 2.3 percent.

Below Trend

“Growth that is likely to spend the next couple of quarters below trend reduces the urgency for the bank to hike,” said David Tulk, chief Canada macro strategist at Toronto-Dominion Bank’s TD Securities unit.

At his last interest rate decision on Sept. 5, Carney reiterated his intention to raise an interest rate that’s been at 1 percent for two years, the longest period of unchanged policy rates since the 1950s.

Other Canadian reports have shown little pressure for Carney to raise interest rates soon. Consumer prices advanced 1.2 percent in August from a year ago, below the central bank’s 2 percent target, and realtor reports have signaled home price increases are ebbing in major cities where Finance Minister Jim Flaherty had said there were signs of overbuilding.

Statistics Canada’s gross domestic product report last week showed declines in construction and activity by real estate brokers and agents.

Carney and Flaherty have said that corporations should use the hundreds of billions of dollars of cash on their balance sheets to boost investment and foster the recovery. Government stimulus and lower interest rates helped lead Canada out of a global recession triggered by the 2008 financial crisis ahead of other G-7 countries.

U.S. Exports

Canada sends three-quarters of its exports to the U.S., where the Federal Reserve last month expanded extraordinary asset purchases to boost growth.

“As far as U.S. demand for Canadian exports, there isn’t a whole lot of momentum,” Shenfeld of CIBC said.

Statistics Canada said last week that mining and oil and gas extraction fell 0.3 percent in July, the third straight decline, led by a drop in crude production, Canada’s largest export.

Canada’s fiscal situation, while better than many of its peers in the Group of Seven nations, is still likely to be a drag on growth. Flaherty said last week that international events are threatening the country’s growth prospects.

“Canada is still growing, better than most, but we are not immune to downside risks originating outside our country and the economic challenges faced by some of our largest trading partners,” Flaherty said in a speech in Ottawa.

Debt Issues

The country also “has to deal with the debt issues that have been looming in Ontario and Quebec,” Dawn Farrell, chief executive officer of utility TransAlta Corp., said in a Sept. 20 interview in Banff, Alberta. “Things are coming off a bit in the very, very short-term.”

Ontario and Quebec are Canada’s largest provincial economies, with both governments seeking to curb budget deficits. Ontario Finance Minister Dwight Duncan said last week he is putting a ‘pause’ on public sector wages and cutting spending.

One remaining source of strength for Canada is business investment, which will probably stay strong as commodity prices remain high, said Paul Ferley, assistant chief economist at Royal Bank of Canada in Toronto. Policy makers have to remain aware of the risks of keeping interest rates close to record lows for a long time even if growth is “modest” in the near term.

“Any tightening is going to be very gradual -- the Bank of Canada doesn’t want to derail signs of improvement,” Ferley said.

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