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Tuesday April 22, 2008 - 12:43:38 GMT
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Market Preview: Loonie and CGBs Unlikely to See Big Moves if BOC Cuts 50 bps (Repeat)

08:13 04/22 (CEP News) – A half-point cut from the Bank of Canada is strongly priced into markets, but it’s not a sure thing. Strategists say fixed income and foreign exchange markets are likely to be volatile following Tuesday’s rate decision.

Overnight indexed swaps and BAX contracts are pricing in an approximately 95% chance the Bank of Canada will cut the target rate by a half point to 3.00%. Max Clarke, fixed income strategist at IDEAglobal, said there is a broad consensus for a half-point but it’s not a certainty.

“There’s some risk they might only do 25 [basis points],” Clarke said, noting the Bank of Canada’s penchant for surprising the market.

Clarke said CGBs will initially sell off, then prices will plateau close to their current levels if the bank cuts by only a quarter point.

“There would be a sell off but you should see some sustained pressure to increase prices. Conditions aren’t going to suddenly turn,” he said.

Several strategists said that traders have attempted to scale back expectations of a half-point cut because worries about worldwide inflation have been growing. If the Bank of Canada cuts by 50 basis points as expected, June futures are pricing in only a 50% chance of an additional quarter point cut.

“The market has in its mind that the Fed isn’t going to do much more than another 25 [basis points] and that’s probably playing into expectations to some degree,” said Shaun Osborne, chief currency strategist at TD Securities.

Given the uncertainty of the market going forward, Osborne expects the statement accompanying the rate decision to be closely scrutinized. “Given that a 50 basis point cut is pretty much factored in here I don’t know if it will make that much of a difference. It will be more about the tone of the statement,” he said.

In the statement from the March 10 decision where the Bank of Canada cut rates by 50 basis points, policy makers reasoned that though “domestic demand has remained buoyant,” the U.S. economy was likely to “experience a deeper and more prolonged slowdown than had been projected.” On inflation, the statement said the balance of risks “has clearly shifted to the downside.”

In his most recent comments at the G7 summit in Washington, Bank of Canada Governor Mark Carney continued to signal worry about a U.S. slowdown.

He told CEP News it has become clear that the U.S. slowdown has been "more marked and more prolonged" than the BOC had expected. But more important than determining whether the present growth in the American economy is flat, slightly negative or slightly positive, he said, is the speed of recovery as it heads into 2009. "That’s what we’re thinking through now."

Osborne said comments about the U.S. economy will provide strong insight into the central bank’s future course of action. He said the Canadian dollar could sell off if there’s a good indication the situation globally and in the U.S. is worse than they had expected.

“They could also swing the other way and be a little more constructive. That will probably be a pretty significant variable,” Osborne said.

The Canadian dollar has traded within three cents of parity since mid-November and Osborne expects that to continue. “We’re still stuck in this range. We’ve had a number of different variables that could have had a significant impact on the Canadian dollar over the last few weeks that really haven’t had any effect,” he said.

Shane Enright, currency strategist at CIBC World Markets, expects a half-point cut but said the Canadian dollar could test the upper end of the range if the Bank of Canada surprises with a 25 basis point cut.

“I would expect a significant reaction. It would push us to the strong end of the range,” Enright said.

Even if the bank cuts by 50 basis points and isn’t overly dovish, Enright said the Canadian dollar could get a boost when some of Canada’s surging commodity companies report quarterly results later in the week.

Enright also said any signs of economic improvement in the U.S. will benefit the loonie. “Canada has traded at a bit of a discount … Risk aversion seems to have dropped, if the market gets some good news from the U.S. it could really take the Canadian dollar stronger.”

Not only will market watchers be waiting for the Bank of Canada decision at 9 a.m. EDT, they will be waiting to hear if Canada’s big banks cut lending rates in tandem. Hank Cunningham, director of fixed income at Blackmont Capital, said any reluctance from commercial banks would set up a major showdown.

“What’s going to be very important tomorrow is whether the commercial banks follow suit. That’s going to be the key,” Cunningham said. “Because if they don’t cut mortgage rates and lending rates then what’s did the Bank of Canada accomplish?”

There have been reports that commercial banks may not follow the central bank because the credit crunch has led to higher intrabank lending rates. Typically, Canadian banks will announce a cut in lending rates several hours following a decision but at times, they have waited until the following day.

Cunningham expects a 50 basis point cut but said there may be a higher risk of 25 basis points than the market is pricing because credit market pressures have eased in the past week.

“The Bank of Canada has been known to surprise in the past, so we’ll see,” Cunningham said.

By Adam Button, abutton@economicnews.ca, edited by Cristina Markham, cmarkham@economicnews.ca

(END) ©CEP Newswires - ©CEP News Ltd. 2008. All Rights Reserved. www.economicnews.ca

Related recent stories:
(08:15 04/22) CA Preview: Most Economists Expect 50 Point Cut to BOC Rate (Repeat)
(07:36 04/22) Tuesday's Events: BOC Interest Rate Decision, U.S. Existing Home Sales
(18:02 04/21) Market Preview: Loonie and CGBs Unlikely to See Big Moves if BOC Cuts 50 bps

 

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