Bank of Canada has room to cut rates

Inflation figures being released this coming week are widely expected to show that the Bank of Canada has a lot of room to cut interest rates to stimulate what other recent figures clearly show is an economy that is weakening.

"Canada is a unique case, with the loonie damping overall inflation pressures, allowing the Bank of Canada to cut interest rates to help offset the effects of a ravaged export sector," noted BMO Capital Markets economist Benjamin Reitzes.

And it has lots of time to do that, he suggested.

"The buoyant loonie continues to keep inflation subdued and, if it manages to stay near parity, don't be surprised to see even lower prices for many goods in the months and years ahead."

BMO is projecting that the February consumer price index report being released Tuesday by Statistics Canada will show consumer prices rose 0.3 per cent during the month to 1.8 per cent higher than a year earlier, an inflation rate that would be below the Bank of Canada's two per cent target, and down from 2.2 per cent in January.

Further, BMO expects that core inflation, which excludes volatile energy and food prices, and which the central bank monitors for underlying inflation trends, will slip even lower to just 1.3 per cent, from 1.4 in January.

In fact, core inflation over the coming few months could slip below one per cent, which is the bottom of the central bank's one-to-three per cent target range, he said.

That would give the bank added incentive to cut rates.

Markets anticipate Bank of Canada governor Mark Carney will cut rates by a further half a percentage point at the bank's next rate review meeting in April.

While analysts agree on the need for lower interest rates to deal with an economy that some now expect will only narrowly avoid being pushed into a recession by the U.S. slump, a Statistics Canada's report that was to come out today on January manufacturing shipments may mask that need.

It was expected that factory shipments, padded by strength in petroleum product deliveries, will rebound from their steep plunge in December, which was exacerbated by auto-plant shutdowns for maintenance and retooling.

"However, January's results will likely be an anomaly as continued weakness in the U.S. economy increasingly leads to a reduction in demand for Canadian goods," said Scotiabank economist Karen Cordes.

While Canadians have to wait until next month for further interest rate relief, Americans will get a badly needed further rate cut on Tuesday, and one that could be a hefty three quarters of a percentage point.

"In the U.S., attention will be squarely focused on the subprime crisis and Tuesday's Fed meeting," noted analysts at CIBC World Markets.

"The only real question is how aggressively the Fed cuts," they said, predicting a three-quarter point reduction, but noting the economic reports out of the U.S. suggest even more might be warranted.

Other U.S. reports this coming week on industrial production and capacity utilization, housing starts, building permits and retail sales are all expected to reinforce the view that even further rate cuts will be needed.

(prepared by Eric Beauchesne/Vancouver Sun)