Forex Investment and Currency Trading

Economic Fundamentals versus Rhetoric

-There is an interesting contrast in the report between the economic assessment and the forward-looking aspects of the statement. The economic, inflation, and credit crunch outlook are all rather dreary, yet the Bank of Canada then waffles a little on the nature of further cuts. Why is this?

-The BoC downgraded its Canadian GDP forecast for 2008 and 2009 from 1.8% and 2.8% to 1.4% and 2.4%, respectively. It now projects that the Canadian economy will not return to full capacity until mid-2010, and that Canadian inflation will remain too low until 2010 (instead of 2009) as well. The motivations for this re-assessment are “a deeper and more protracted slowdown in the U.S. economy… [with] …direct consequences for the Canadian economic outlook.” Moreover, “tightening credit conditions and softening sentiment are expected to moderate business investment and consumer spending.”

-The reason the Bank of Canada was able to hedge its bets on the timing and quantity of further rate cutting is that it has already delivered 100bp of easing since recognizing that its previous forecast was too optimistic. The March 4th rate decision (also a 50bp cut) was explicit in acknowledging that the risks to the prior forecast were to the downside, though the BoC only formally revises its forecast at every second decision. In turn, it is not simply enough to observe that things are worse and that further rate cutting is required. The question is whether things are bad enough to warrant much more than the 100bp of compensatory rate cutting that has already occurred.

Balanced Risks

-On a related note to the prior observation, why are the Bank of Canada’s risks to its outlook now “balanced”, whereas they had “clearly shifted to the downside” in March?

-It is important not to read too much into this one. This is not a hawkish statement. As noted above, the BoC formally revises its forecast at every second meeting. Between forecasts, it is clearly legitimate to acknowledge that one’s prior forecast may have missed the mark, and thus that the risks now tilt up or down. But when the BoC updates its forecast, it would be awfully strange to shoot one’s new forecast in the foot by suggesting that it does not reflect one’s central view. Any bias should be reflected in the updated forecast, taking the risks back to balanced.

“Underlying Trend of Inflation”

-There is another quirk in the latest Bank of Canada statement, which is the comment that “the underlying trend of inflation is judged to be about 2 per cent.”

-Suppose there is some flexibility in the word “trend”, but have trouble squaring this statement against the fact that most conventional measures of Canadian inflation are well below 2%. To start with the obvious, Y/Y core CPI is 1.3% and Y/Y headline CPI is 1.4%. The core CPI 3m and 6m annualized trends are 1.8% and 0.7%, respectively. The headline CPI 3m and 6m trends are 0.7% and 1.4%, respectively.

-Having ruled out those common measures, there are two plausible things that the Bank of Canada is looking at. One is an alternate set of Canadian inflation measures, perhaps including the re-weighted mean CPI, trimmed mean CPI, and the weighted median CPI. These are looked at rather closely in places like Australia, and the Canadian versions point to Y/Y inflation at 1.9%, 2.1%, and 2.5%, respectively.