INTEREST RATES: Bank forcast to keep lid on rates

The Bank of Canada today is widely expected to stick to its policy of holding the bank rate steady until the end of June despite signs of an improving economy.

What are the expectations?

The commitment by the central bank to hold the rate steady at 0.25 per cent is helping to keep the yield on two-year Canadian government bonds in check, while the Canadian dollar has been relatively steady during the past four weeks.

The overall health of the economy continues to be hurt by the strong loonie and its effects on manufacturing, exports and commodity revenues.

"While the tone of the accompanying communiqué should not change substantially, it is possible that bank may decide to tilt the inflation risk from the downside to balanced – which would be a meaningful change and put focus squarely on how hard and fast the market expects the second-quarter 2010 date will hold," said Andrew Spence, global head of foreign exchange and rates research for TD Securities Inc. TD Securities expects rates will be held steady.

How will market react?

"I think the most important factor that determines the direction [of a currency] is the direction of interest rates," said Aaron Fennell, a senior markets strategist with futures broker Lind-Waldock Canada, a division of MF Global Canada.

The Canadian dollar is being held down by the Bank of Canada's interest rate policy, Mr. Fennell said.

"They are absolutely using interest rate policy to control the dollar," he said. "They can only do that for a certain amount of time before the robust forces of the economy overrides the Bank of Canada's intentions."

The loonie could continue to trade in a narrow range for the next few weeks, but early in 2010 it could increase in value to par with the U.S. dollar.

"I personally think it will get through par in the first or second quarter of 2010," Mr. Fennell said. The Canadian dollar yesterday traded at 95 cents (U.S.).

"Policy making in Canada has gotten quite complicated," said Paresh Upadhyaya, senior vice-president and currency portfolio manager with Boston-based Putnam Investments.

If the improved economic trends continue within three or four months, the Bank of Canada could be under pressure to tighten sooner rather than later and possibly before the United States, leading to unwanted further appreciation of the Canadian dollar, he said.

(prepared by Allan Robinson/Globe & Mail)