Global Trade: Canada Takes Its Cues from China Now

It could be called the China Club, a special group of nations whose exports of raw materials increasingly fuel China's industrial machine. As China booms, the central banks of four members of this group—Australia, Brazil, Malaysia, and Peru—have already raised interest rates this year to tame brisk growth and inflation in their own economies.

Now investors are expecting Canada to raise rates sometime in June or July. Canada's position is in sharp contrast to the U.S., where the Federal Reserve probably won't raise rates until next year, or to Europe, mired as it is in its worst crisis in decades.

The Bank of Canada traditionally followed the Fed's lead in setting rates. Not this time. Demand from China, India, Korea, and other Asian economies has helped produce Canada's fastest growth in a decade.

The economies of Canada and the U.S. will grow 3.1 percent in 2010, faster than other G-7 countries, according to an International Monetary Fund forecast. Next year, however, U.S. growth will slow to 2.6 percent while Canada will continue to expand by 3.2 percent. Inflation in Canada, Bank of Canada policy makers said in an Apr. 22 report, will exceed the target rate of 2 percent this year.

Bank of Canada governor Mark J. Carney cited the momentum in emerging markets when he recently dropped a conditional pledge to leave his policy rate unchanged through June. China's sovereign-wealth fund agreed on May 13 to invest $769 million in an oil-sands venture with Calgary-based Penn West Energy Trust (PWE). Vancouver-based Teck Resources (TCK), Canada's largest base-metals producer, reported on Apr. 20 that first-quarter profit more than tripled, to $854 million, as copper prices climbed on increasing demand from China.

Canada's exports to China rose 6.6 percent, to $10.5billion last year. China has replaced Japan as Canada's third-largest export destination after the U.S. and U.K. "We have a great advantage over Britain, the U.S., and most countries in Europe," says Serge Coulombe, professor of economics at the University of Ottawa.

A rate hike looks certain, but the timing may depend on the turmoil in Europe. Carney "will still want to raise interest rates but needs at least a window of calm in equity and commodity markets to do that," says Avery Shenfeld, chief economist at CIBC World Markets in Toronto. While he predicts a June 1 move, "further downside would put the Bank of Canada in a position where it will be safer to wait until July."

The bottom line: Asian demand for Canada's raw materials should compel Canada's central bank to move more quickly than the Fed in hiking rates.

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