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Today the Bank of Canada revised its interest rate policy to 1.0%

  • The Bank of Canada (“BoC”) raised its benchmark rate by another 25 bps this morning to 1.00%. .
  • Interestingly, since the BoC’s first rate hike (June 2010), the Canadian Swap curve has actually flattened. The 3-month CDOR rose by more than 40 bps while the 5-year swap rate declined by more than 80 bps.
 The Bank of Canada press release highlights:

  • In the United States, the recovery in private demand is being held back by high unemployment and recent indicators suggest a more muted recovery in the near term.
  • Economic activity in Canada was slightly softer in the second quarter than the Bank had expected.
  •  The Bank now expects the economic recovery in Canada to be slightly more gradual than it had projected in its July Monetary Policy Report (MPR), largely reflecting a weaker profile for U.S. activity.
  •  Inflation in Canada has been broadly in line with the Bank's expectations and its dynamics are essentially unchanged.
  •  Any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook.
The rise in rates was widely anticipated by the market (although the odds of an increase had fallen slightly to 50/50 over the past few weeks).  The statement is far less bearish than I had anticipated; on the other hand the market is pricing a 20/80 chance of a further raise to 1.25% in November.

More interesting is the shape of the interest rate curve which has flattened dramatically over the past few months.  No economist predicts deflation in Canada, strong resources based economy should insure that things will continue on their current path.  Yet inflation is very tame, and is not expected to trend towards the upper boundary (3%).  However, inflation risks are abating (currently around 1.6%) and Canadian money growth is well within the bound dictated by economic growth of 3.2% for 2010, and 2.5% for 2011. 

HISTORICAL FLATTENING OF THE CANADIAN SWAP CURVE
As we can see, the Canadian swap curve has strongly flattened in four month.
(Canadian swap rate curve)

 

BTW I was wrong on interest rates, I really thought that the BoC would hold off on a 0.25% rise

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