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Tuesday September 7, 2004 - 20:33:50 GMT -

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Canadian Dollar Braces For Rate Hike

DailyFX Forex Fundamentals 09-07-04

By Kathy Lien, Chief Strategist of

·Greenspan Expected to Solidify Case For Rate Hike Tomorrow
·Cad Rallies As Bank of Canada Expected To Raise Rates By Quarter Point
·Pound Slides On Decreasing Industrial Production
·Yen Soars As Japanese Private Capital Spending Increases By Fastest Pace Since 2000


The US dollar fell close to 1% against the Canadian dollar on a much stronger than expected IVEY PMI survey indicating strong business and spending growth. Tomorrow, the Bank of Canada is expected to announce their first rate hike since shedding their accommodative monetary policy. With stronger than expected second quarter GDP growth, the BoC will be forced to respond with more aggressive tightening in order to prevent an excess demand crisis. Core inflation has been gradually increasing while the central bank has kept rates steady. This has pushed the real policy rate to 0.1% (2.0% target rate minus 1.9% core CPI). The market is pricing in 75bp of tightening by year end. The Bank of Canada is expected to bring the real policy rate back towards a neutral level over the next few monetary policy meetings, which would coincide with a target rate of approximately 3.5% - 4%.


Today is best characterized as a day of completely lifeless trading in the euro with the market holding its breath ahead of Greenspan’s testimony on the economy and the fiscal outlook tomorrow morning (14:30 GMT, 10:30 EST). The market expects the Fed Chairman to validate the need for another rate hike this month, with oil prices falling 13% from its August 20th high, which Greenspan will likely take as a confirmation that the negative factors affecting the economy are “transitory.” The triple digit non-farm payroll gains seen in August also provide Greenspan with supporting evidence that the rebound in the economy continues. Another quarter point rate hike is already priced into the market so traders will also need to look to the details of the Fed’s Beige Book report to see how widespread payroll gains and activity are across the country. Keeping the euro afloat is stronger than expected German industrial production, which increased 1.6% in the month of July. This is the strongest gain in 9 months led almost completely by a surge in consumer durables production. Meanwhile, the ECB is becoming increasingly hawkish. According to Market News, ECB Quaden said that, “the recovery in the Eurozone has largely materialized,“ suggesting an end to their accommodative monetary policy bias.


Although the dollar barely budged against the euro, it soared against the Swiss franc as the level on unemployment increased the most in almost 12 months. The shortfall came as the number of available jobs decreased in the month of August. Swiss National Bank Director Hildebrand is scheduled to speak tomorrow. The market will be looking for clues to the central bank’s monetary policy bias ahead of the upcoming monetary policy meeting. Switzerland is also scheduled to release their second quarter GDP report on Friday. The Swiss economy is improving at a very slow pace, leaving many domestic firms cautious about increasing spending. Meanwhile in the US, as mentioned in our euro commentary, the market is quietly awaiting for Greenspan’s testimony tomorrow morning. In a speech in Dallas today, Fed President McTeer said that he expects the jobless rate to improve and the third and fourth quarter growth to be “better.” He also added that a “measured” pace by the Fed would leave rates “very low.” The current real fed funds rate is negative to zero. It will be dollar positive if Greenspan makes similar comments and suggests that the Fed may be moving towards a less “measured” pace of tightening.


The pound took a beating today as industrial and manufacturing production decreased for the second consecutive month. The market had expected a rebound given the increase in the CIPS manufacturing sector PMI survey for the month of July. Output in the beer and pharmaceutical industry plummeted, leaving the market completely convinced that the Bank of England will leave rates unchanged on Thursday. Although we think unlikely, it has even swayed some to believe that the BoE may already be at the end of their tightening cycle. Today’s IP data indicates that the slowdown in the economy is becoming more widespread. The National Institute of Economic and Social Research said that GDP growth for the three months ending August 31st slowed to 0.8% from 0.9% (for the three months ending in July).


The dollar has retraced almost all of last week’s gains against the dollar on healthy economic data. Capital spending increased a much stronger than expected 10.7% y/y between April and June. This is very positive for Friday’s GDP report, which is now expected to be revised up significantly from the initially reported 1.7% to 3.4%. Leading economic indicators and the coincident index confirm continued strength in the overall economy, putting the focus back on Japan’s impressive growth. It should be no surprise that the Bank of Japan will leave rates unchanged at their policy meeting tomorrow.


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