CIBC Rate Forecasts

Some key forecasting
• Prime to rise to 5.50% in 2006 and then drop back down to 5.00% in 2007.
• 10 Year Gov't Bond yields to drop by 30 basisPOINTS by the end of December (P-1.50% for 1 year and the ability to lock in after the teaser period to forecasted lower rates in Dec). Bond Yields predicted to drop further in 2007.
• Cdn dollar to surpass 90 cent threshold and then, when B of Canada forecasted to lower rates in 07, Cdn dollar predicted to weaken to 83/84 cents at that time.

Interest Rate Forecast.

There is speculation that the Bank of Canada may not be as aggressive as originally thought on rate increases this year due to unexpected job losses in December and a slowdown in business spending. Currency traders now only expect two rate increases this year, instead of the 4 they predicted earlier.

Canada's Dollar Falls on Speculation of Fewer Rate Increases Jan. 9 (Bloomberg) -- Canada's dollar fell for a third day on speculation signs of slowing economic growth may curb the pace of interest-rate increases. The Canadian currency fell last week as reports showed business spending slowed to the lowest since July 2003 and the economy unexpectedly lost jobs in December.
The Bank of Canada lifted its benchmark overnight rate three times since September, to 3.25 percent from 2.5 percent. Policy makers next meet on Jan. 24 and March 7.

``The market has priced out more aggressive moves from the Bank of Canada,'' Marc Levesque, chief strategist at TD Securities in Toronto. ``This is working against the Canadian dollar.'' Canada's dollar fell 0.6 percent to 85.25 U.S. cents at 9 a.m. in Toronto, from 85.80 U.S. cents on Jan. 6. One U.S. dollar buys C$1.1730. The currency has fallen from 87.45 U.S. cents on Dec. 14, which was the highest since January 1992. Levesque predicted the Canadian dollar may weaken to C$1.20, or 83.33 U.S. cents, by the end of this year. Traders now only expect two more rate increases and see less than a 50 percent chance for a third increase this year by the central bank, said Levesque. At the beginning of last week, traders expected four more rate moves by the central bank, he said. Futures Yields The yield for the March bankers' acceptances futures contract fell to 3.80 percent from 3.95 percent at the beginning of this year, which was near the highest in more than a year. Traders use bankers' acceptances contracts as a gauge of expectations for the Bank of Canada's benchmark rate. The futures settle at a three-month lending rate that has averaged 16 basis points above the central bank's rate target since Bloomberg started tracking the gap in 1992.

Futures traders have decreased their bets that the Canadian dollar will gain against the U.S. dollar, figures from the Washington-based Commodity Futures Trading Commission show. The difference in the number of wagers by hedge funds and other large speculators on an advance in the Canadian dollar compared with those on a drop -- so-called net longs -- declined to 36,687 as of Jan. 3, compared with net longs of 56,183 as of Dec. 13, the highest ever.

Economy and rates

The credit cycle is turning. The Bank of Canada is operating under the assumption that the economy is close to full capacity — pointing to the 30-year low unemployment rate as a reflection of this reality. Furthermore, due to slow productivity growth, the Bank believes that the speed at which the economy can grow without triggering inflation is now 2.5% and not 3% as previously estimated. This means that the Bank has more room to raise rates. How high will interest rates go? The likelihood is that the current monetary policy tightening campaign will be much more muted than it was in the past.
The prospects of rising interest rates along with elevated commodity prices will continue to underpin the Canadian dollar which, in turn, would further hurt activity in the manufacturing sector. So, in many respects, the strong dollar is doing the Bank of Canada’s job by slowing down the economy. In addition, the Bank of Canada is facing a difficult dilemma as the national economic figures mask growing regional divergence. The twin effects of high-energy prices and a strong dollar have created two economies in Canada: The West vs. the Rest. Note, for example, that in 2006 economic growth in Alberta might outpace growth in Ontario by a ratio of four to one. And ironically, higher interest rates are much more powerful where they are least needed (Central and Eastern Canada), and less effective in the booming areas (Alberta).
This asymmetrical response to higher interest rates, along with the negative impact of a strong dollar and higher energy prices on overall economic activity will work to limit the need to raise interest rates in the near future. Accordingly, we expect the Bank of Canada to raise rates by only 50-75 basis points in the coming few months, with the dollar remaining at well above the $0.85 (US) level.
As for long-term rates, the increase here will be even more muted given the diminishing correlation between short and long-term interest rates. In other words, major global economic factors such as the globalization and the Wal-martization of the North American economy, work to keep inflation at bay. And with inflation low, long-term rates are not rising asquickly as they did in previous cycles. So, short-term rates are no longer the main drivers of long-term rates. Accordingly, expect the 5-year rate to rise by no more than 25-30 basis points in the coming few months before leveling off.
While most observers focus on the upcoming rate hikes by the Bank of Canada, it is important to note that if indeed the Canadian dollar continues to appreciate (a real possibility), real estate activity levels off (very likely) and elevated energy prices continue to squeeze the pricing power of consumers, then by 2007 we might be talking about rate cuts, not rate hikes.

article is for informational purposes only and the information, opinions and statistical data are deemed reliable.