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Damn! I hate being wrong

Was I talking my book when I predicted that Canadian interest rates would rise by 0.25%?  I guess I was because the Governor of the Bank of Canada and his buddies decided that the external risks are too great to Canada’s economy and that interest rates should remain at the current 1% rate.

In fact, the current interest rates are very accommodative, for an economy that just saw spectacular trade numbers (Canada is back at having a trade surplus), moreover, with oil prices remaining around the $100 mark, the trade surplus is bound to remain.  Inflation pressure are certain to be relatively muted in Canada, the strength of the CAD (now at 1.03 to the USD) will insure that imports will act as a deflator.  GDP growth for 2010 is now estimated to have topped the 3.2% (well ahead of the BoC’s 2.8% target), exceeding the U.S. numbers that have just been revised downwards.

I want to get back to interest rates, because their current level is so very low (by historical standards).  The interest rate which the Canadian economy anticipates is usually around 3% to 4%, with longer dated interest rates around 6-7% range.  Clearly, borrowers are happy with the current state of affaire since borrowing rates are so low it pays for consumers (and businesses) to borrow – proof in the pudding is that Canadians have the highest level of personal debt (yes we are now worse than the Americans).

As David Rosenberg said this morning, Canada achieved an impressive level of growth without the Bank of Canada blowing-up its balance sheet, and while the Canadian government maintains a “healthy” budget deficit (around 5% of GDP, and a structural deficit of 1.5%).  Strictly speaking if the Canadian government’s spring budget included a boost in tax revenues and same smallish reduction in expenditure, Canada could be the only OECD country with no structural deficit… we shall see [election fever is in the air].

It remains that there are consequences to extremely low interest rates, first is the impact on pension funds.  Since, most are assuming an IRR of 7% p.a. when the long term Canadian bond rates are around 3.5%, we have a problem with pension solvency.  In fact, the BoC may have decided that the strength of the Canadian dollar is a sufficient dampener to Canada’s inflation exposure.

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