Monday, May 31, 2010

Will Canada Lead G7 Rate Hikes?

Reuters reports, World trade growth slows in 1st qtr:

Global trade volumes in the first three months of this year were 5.3 percent higher than in the previous quarter, representing slightly slower growth than in recent months but still a healthy rebound from the crisis, data from the Dutch CPB institute showed on Monday.

The CPB, whose data are used by the European Commission and World Bank, said world trade in the three months ended February had grown by 5.8 percent over the previous three months and grown 6.0 percent in the last quarter of 2009.

Trade growth remained strongest in Asia and Latin America, but was relatively low in the euro area, it said in its latest monthly world trade monitor.

On the more volatile monthly figures, world trade volumes were 3.5 percent higher in March than in February, when they grew 1.7 percent.

Trade volumes grew worldwide except for Japanese imports, and both imports and exports in the euro area were strong.

World trade in March was 4 percent below the peak reached in April 2008 and 21 percent above the trough seen in May 2009.

The CPB report also showed a pickup in world industrial production:

On the basis of preliminary data, world industrial production grew by 0.2% in March 2010, following an unrevised 1.0% increase in February. Production continues to grow in all regions, emerging Asia excepted. In March, industrial production was 1.9% below the peak level reached in March 2008. It has risen by an accumulated 12% from the March 2009 trough. In the first quarter of 2010 production was up by 10.9% on year ago, the highest such value in our series (which start in 1991).
Robust global trade helped Canada register a record 6.1% gain in Canadian GDP during Q1. Phred Dvorak of the WSJ reports, Canada's Growth Sets Stage for Rate Increase:

Canada's economy grew at the fastest pace in more than a decade during the first quarter of this year, a stronger-than-expected performance that cemented expectations of an interest-rate increase on Tuesday.

Gross domestic product rose an annualized 6.1% during the three months ended March 31, fueled by continued growth in consumer spending and manufacturing, Statistics Canada said. That growth was more than double what the U.S. economy reported during the same period, and stronger than both the Bank of Canada and analysts' consensus forecasts of 5.8%. It contrasts sharply with an annualized contraction of 7% a year earlier, in the first quarter of 2009.

The strong performance highlights how Canada's healthy financial system and relatively unscathed consumers have underpinned a fast rebound from the downturn of the past two years. Consumer price levels, job creation and housing sales are all rising in Canada, pointing to a solid recovery, even as peers like the U.S. see falling inflation and uncertain consumer demand.

The robust economic growth also sets the stage for what is expected to be the first interest-rate increase among the Group of Seven wealthy nations following the financial crisis. The Bank of Canada is widely expected to say at its Tuesday policy announcement that it is raising its target overnight interest rate by 25 basis points, or hundredths of a percentage point, to 0.5%. Many expect that tightening to continue, raising the overnight rate to 1.5% by the end of the year, according to a survey of economists by Dow Jones.

Some central bank watchers warn there are risks to tightening interest rates in Canada now. The situation in Europe remains volatile after fears of a Greek debt default prompted a bailout from the European Union, followed by credit downgrades of countries such as Spain and Portugal. Banks report that credit is tightening again and global equity markets have weakened.

"Even though the lagging economic data have improved measurably, there has already been enough of a tightening of economic conditions to allow the bank to sit back and assess how the debt crisis unfolds," says David Rosenberg, chief economist at wealth manager Gluskin Sheff & Associates Inc. in Toronto.

Mr. Rosenberg warns that if the Bank of Canada raises rates and global credit markets weaken further, it may have to reverse course, as it did in 2002—the last time it raised rates ahead of the U.S. Federal Reserve.

Most economists also expect Canada's growth to cool down on its own. Some measures that the government implemented to boost consumption—including a popular tax break on home renovations—have expired. Roaring housing sales are slowing as mortgage rates and prices rise. Canada is unlikely to sustain the rapid inventory buildups and high levels of consumer demand that characterized the first quarter, says Douglas Porter, an economist at BMO Capital Markets in Toronto, who is forecasting GDP growth of 3.4% for all of 2010.

Mr. Porter, though, still expects the Bank of Canada to start raising rates on Tuesday—even if it pauses later in the year.

"I have a lot of empathy for how hard the decision is," he says. "But I think the domestic case is so strong that they should be raising interest rates."

I think Mr. Porter is right, the Bank of Canada will likely raise rates on Tuesday. I met up with one of the best economists in Canada during lunch on Monday and he told me that he sees the Bank raising rates as well.

As far as the US is concerned, he told me that strong productivity growth is allowing the Fed to remain on the sidelines "till September", but after that they too will start raising rates.

In fact, he told me that policy rates around the world "are way too accommodative" and that too many bears are focused on events in Europe without understanding the improving fundamentals in the US. He's waiting for a payroll figure of over 500,000 on Friday, and I think it might even be higher.

Anyway you slice it, fundamentals are improving, and rate hikes need to take place to remove some of the excess stimulus that was put in place to fight off the recession. It looks like Canada will be the first among the G7 to start hiking rates. It will be gradual, but expect more rate hikes ahead in Canada and elsewhere.

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