- BoC, ECB, BoE, remain on hold
- Job market in Canada improves; worsens in U.S.
- Stock markets plunge
As the battle between economic growth and inflation continues, most central banks around the world are caught on the fence. Indeed, central banks in Canada, Europe and the U.K. all left interest rates unchanged this week, as they wait to see which risks materialize. Australia's central bank, however, succumbed to the downward pressure on economic growth, and cut rates by 25 basis points this week. This was the first cut Australia has seen since 2001, but policy makers tempered market expectations when they signaled that it is not an indication that more cuts are in the pipeline.
Inflation concerns prevent rate cuts in the U.K. and Eurozone
Despite an economy flirting dangerously with a recession, the Bank of England held interest rates steady yesterday, as inflation - at 4.4% - is more than double the target rate, and upside risks remain. Still, with oil prices well off their July highs, we feel that the deteriorating economy will soon outweigh inflation concerns and lead to rate cuts in the U.K. - perhaps even by next month. Similarly, the European Central Bank (ECB) stood pat yesterday in spite of a second quarter contraction in economic growth and the bank's subsequent lowering of GDP growth forecasts for 2008 and 2009. ECB President Trichet cited upside risks to inflation as the motivation behind the decision, as price stability is the bank's primary objective. While the upper bounds of the bank's inflation forecast for this year and next did not increase, we still feel that high inflation levels will prevent the ECB from beginning an easing cycle before March of 2009.Bank of Canada holds rates steady at 3.00%
In Canada, the decision to hold rates steady at 3.00% was widely expected by analysts. Still, the futures market was pricing in a 30-40% chance of a rate cut after second quarter GDP growth came in at a meager 0.3% following a contraction in the first quarter. However, the BoC did not feel that flat economic growth was enough to warrant a rate cut. In fact, they argued that the current level is “appropriately accommodative”, suggesting that they are in no hurry to cut rates.
The communiqué that accompanied the decision suggests that the BoC views the upside and downside risks as roughly balanced. While upside risks to inflation still exist, they seem to have been tamed by the recent pullback in commodity prices - which also implies that inflationary pressures will be less-than-expected. The BoC maintained the view that core and headline inflation will converge to the 2% target rate by the second half of next year. On the growth front, the Bank deemed economic growth in Canada to be lower than anticipated, but still “close to production capacity”. However, concerns over the interplay between the U.S. economy and tight credit conditions hinted that the central bank will likely downgrade their U.S. growth forecast for 2009.
Overall, we view the Bank's comments to be relatively neutral, which will likely reduce market expectations for future rate cuts. And unless significant and unexpected weakness seeps into the labour and/or housing markets, or the stress on Canadian financial markets worsens, we feel that the next move by the BoC will be a rate hike - but not until the second half of 2009.
Canada adds 15,000 jobs in August
This morning's better-than-expected employment report offered some support for the BoC's decision to leave rates unchanged. After shedding 55,000 jobs in July, the Canadian labour market rebounded modestly in August, adding 15,000. The gains were fairly broad based, with educational services, construction, and accommodation and food services leading the way. Wage growth fell to 3.8% Y/Y, the slowest pace since July 2007. While still slightly above July's inflation rate of 3.4%, the deceleration will ease wage-push inflation fears.
While job growth in Canada has certainly slowed from the rapid pace seen in 2006-07, August's report provides some reassurance that the labour market is not as weak as July's data would suggest. Even with two months of declines, the average monthly growth rate for this year as a whole is 10,900 - which is consistent with an economy expected to grow by less than 1.0%.
U.S. labour market worsens
The same cannot be said for this morning's U.S. employment report. Not only did the U.S. lose 84,000 jobs in August, but July's loss was revised down to 60,000 from 51,000, and June's loss was revised down to 100,000 from 51,000. This brings the total number of job losses for this year to 605,000, and we wouldn't be surprised to see at least another 200,000 jobs shed before the year is out. And, if the combined 142,000 job cuts reported this morning weren't enough, the unemployment rate jumped to 6.1% in August - up from 5.7% in July and the highest level in 5 years. The 8-month string of job losses reaffirms that U.S. consumers have quite a bumpy road ahead, which does not bode well for economic growth in the coming quarters.
Other data out of the U.S. this week was not much better. Sentiment indicators for both the manufacturing and non-manufacturing sectors came in relatively flat in August, suggesting that the economy continues to struggle with sluggish demand. In addition, the Fed's Beige Book provided anecdotal evidence that economic conditions remain quite weak. Consumer spending was reported to be slower in most districts, particularly in the auto sector, while real estate activity in both residential and non-residential markets appears to have weakened further. Inflation pressures remain a sore spot for producers, and some have managed to push some of the cost increases onto consumers. From every angle, it seems as though the slowdown in the U.S. economy has yet to bottom out and the Federal Reserve will have to remain vigilant, watching out for the upside risks to inflation.
Stock markets take a dive
This week's dismal U.S. economic data had a disheartening effect on stock markets. Despite a shortened week, all U.S. exchanges were in the red. But it wasn't just the U.S. - stock markets around the world have all plunged this week, led by a 13% decline the Oslo Stock Exchange in Norway. Ranking among the top 10 worst performers in the world, the TSX was hit especially hard, thanks to an oil-led commodity selloff. Crude oil prices plunged as low as US$105 per barrel in intraday trading this week - US$10 below last Friday's close. The oil price correction was largely due to the fact that Hurricane Gustav failed to cause as much damage in the Gulf of Mexico as was feared. But the losses weren't limited to just oil. A U.S. dollar rally against the euro, combined with the sharp pullback in oil prices, reduced demand for commodities as an alternative investment. As such, prices of other commodities, particularly precious metals and raw materials also took a dive. And given that the TSX is stacked with commodity producers, it comes as no shock that the index has dropped nearly 9% between last Friday's close and midday today. Going forward, we expect most commodity prices, while highly volatile, to continue to retreat in the near term, which could lead to further bouts of downward pressure on stock markets.
UPCOMING KEY ECONOMIC RELEASES
Canadian Housing Starts - August
Release Date: September 9/08
July Result: 187K
TD Forecast: 200K
Consensus: 190K
There is little doubt now that the Canadian housing market is losing its magic, and all signs are pointing to a moderation in activity as the sector adjusts to the new reality of a softer labour market, sluggish economic activity, and the shift away from a seller's market. Nevertheless, we believe that the outsized correction in housing starts in July was an anomaly, and would expect to see a modest rebound in residential construction. For August, we are looking for housing starts to rise to 200K (from 187K in July), with most of the increases coming from the volatile multiple- units component. Nevertheless, we believe that the level of activity is unlikely to return to the blistering 225K+ pace witnessed during the glory days of not too long ago.
Canadian International Trade - July
Release Date: September 11/08
June Result: $5.8B
TD Forecast: $5.7B
Consensus: $5.7B
After riding on the unrelenting boom in commodity prices in the first half of this year, the first signs of a reversal in fortune for the Canadian merchandise trade balance are expected to emerge in July, with the surplus falling to $5.7B. Indeed, with exports of energy products accounting for over 30% of total merchandise exports, the 4.1% M/M decline in energy prices will certainly not go unnoticed. Nonetheless, during the month, we expect exports to grow by 1.5% M/M, while imports should rise by more meaningful 2.0% M/M. Indeed, although commodity prices have began to fall, Canadian dollar softness should cushion the blow, and there is reason to think that trade in autos - for both imports and exports - could grow. If commodity prices continue to decline, we would expect to see further moderation in the merchandise trade surplus, though some of this will likely be offset by the weaker Canadian dollar.
U.S. Retail Sales - August
Release Date: September 12/08
July Result: total -0.1% M/M; ex-autos +0.4% M/M
TD Forecast: total 0.0% M/M; ex-autos -0.3% M/M
Consensus: total +0.2% M/M; ex-autos -0.2% M/M
With the impact of the fiscal stimulus package now behind us, the unwinding of consumer spending to more sustainable levels is now underway. Retail sales are expected to be sluggish in the coming months as U.S. consumers contend with the considerable headwinds coming from deteriorating labour market conditions, tighter lending conditions, elevated gas prices, and declining home prices. Moreover, with other ancillary indicators (such as same store sales and Redbook sales) pointing to slower consumer spending in August, we expect retail sales to be roughly flat, despite the massive boost coming from the 9.3% M/M surge in motor vehicle sales. Excluding autos, we should see sales falling by a modest 0.3% M/M.
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
