Interest rates cut forecast as loonie heads to 80 cents US.

Bank of Canada 'going to have to get off indecisive rear end,' CIBC economist says

by Jacqueline Thorpe

The Financial Post

Thursday, January 08, 2004
OTTAWA -- The Bank of Canada will cut interest rates by as much as 75 basis points as the loonie's march towards 80 cents US continues to dampen growth in 2004, some of the country's leading economists predicted Wednesday.

"To narrow that interest rate differential [with the United States] and make the Canadian dollar less attractive, the Bank of Canada is going to have to get off its indecisive rear end and ... cut interest rates," said Avery Shenfeld, senior economist at CIBC World Markets.

Shenfeld expects the bank to cut rates by 75 basis points, bringing its overnight target down to two per cent. Don Drummond, chief economist at Toronto-Dominion Bank, and Bank of Nova Scotia chief economist Warren Jestin, both see cuts of 50 basis points.

Tim O'Neill, chief economist at the Bank of Montreal, and Craig Wright, chief economist at Royal Bank of Canada, also say rate cuts are a distinct possibility, but the more likely scenario is for the bank to delay raising rates until late this year.

The five economists, part of a panel on the Canadian economy in Toronto, pegged growth for 2004 ranging on either side of three per cent.  That would be better than growth of around 1.6 per cent expected for 2003, yet well off the four-per-cent plus pace the United States is likely to set.

Investors will get a better idea of how the Bank of Canada is leaning on rates Friday, when deputy governor David Longworth speaks in Toronto. The speech will be the same day as a crucial jobs data report is released, and a week before the central bank's Jan. 20 rate announcement.

The panel agreed the U.S. economy was set for several quarters of strong growth amid low interest rates and massive government stimulus.  Buoyant growth in China and Asia should continue to support commodity prices -- and the Canadian dollar -- and shift growth prospects to Western Canada, Westin said. The brunt of the exchange rate appreciation will fall on Quebec and Ontario, given their heavy manufacturing sectors.

The economists differ on how far the Canadian dollar is likely to rise and what that rise will do the economy.  "Given the strengthening of the U.S. economy, we will see some relaxation of the downward pressure on the U.S. economy and hence that will put a ceiling on the Canadian dollar," Drummond said, though he still expects it to get to 80 cents US. It closed at 77.60 cents Wednesday, down 0.17 of a cent from Tuesday's close.

BMO's O'Neill said Canada's strong domestic economy will buffer the country's suffering export sector.  This is where a stronger loonie will be helpful.  O'Neill expects the dollar to soften from here as strong U.S. growth and central bank tightening gives the greenback at least a temporary boost. He added trying to influence the exchange rate through interest rates is risky business for the Bank of Canada.

"They have been spectacularly unsuccessful [in previous attempts]. Any attempt to engineer a lowering of the Canadian dollar through rate cuts will be as unsuccessful as in the past," he said.  Wright said Canadian exports of high-tech equipment -- the very sector that is booming in the United States -- are now bigger than auto exports.  But the bear amongst the bunch, CIBC World Markets, believes the retreat in the U.S. greenback has further to go and the loonie has further to appreciate.

Monday  January 12 2004
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