Canada Dollar Climbs as Central Bank Signals Further Interest-Rate Boosts

Bloomberg.com   |  September 8 2010 3:24 EDT

Canada’s dollar strengthened after the central bank raised benchmark interest rates for the third time in less than four months and signaled it may increase them again this year as the nation’s economy continues to grow.

The currency climbed versus all 16 of its most-traded counterparts as the Bank of Canada boosted its target rate to 1 percent from 0.75 percent and investors sought higher-yielding assets. The bank said “financial conditions in Canada have tightened modestly but remain exceptionally stimulative.”

“To us that clearly signals the bank is not done raising rates,” Blake Jespersen, director of foreign exchange at Bank of Montreal, said by phone from Toronto. “We now think there’s a fairly decent chance that they raise rates again in October.”

The Canadian currency, nicknamed the loonie, appreciated 1.1 percent to C$1.0366 per U.S. dollar at 2:26 p.m. in Toronto, from C$1.0480 yesterday. It touched C$1.0509 before the rate announcement, the weakest level since Sept. 3. One Canadian dollar buys 96.50 U.S. cents. Government bonds slumped.

Canada’s recovery will be slower than projected because of a weaker outlook for the economy of U.S., the nation’s biggest trading partner, and further rate increases “need to be carefully considered,” the central bank said in a policy statement that echoed its June and July communiques. Still, Canada’s “consumption growth is expected to remain solid and business investment to rise strongly,” the bank said.

“I thought they would express a little more caution this time and they didn’t,” David Watt, senior currency strategist in Toronto at Royal Bank of Canada’s RBC Capital Markets unit, said in a phone interview.

Policy makers’ next two meetings are on Oct. 19 and Dec. 7.

Bonds Drop

Government bonds tumbled, pushing the yield on the benchmark two-year note as much as 14 basis points higher to 1.43 percent, the highest level since Aug. 17. A basis point is 0.01 percentage point. The price of the 2 percent security maturing in September 2012 decreased 23 cents to C$101.17.

Yields on 10-year Canadian notes jumped as much as 13 basis points, the biggest intraday gain since May 10, to touch 2.94 percent. They reached a 17-month high of 3.751 percent in April, before the European debt crisis spurred concern the global economic recovery was floundering and damped investors’ appetite for higher-yielding assets. The yield slumped to as low as 2.745 percent on Aug. 31, the lowest since April 2009.

Ratings Affirmed

Canada’s long-term foreign- and local-currency issuer default ratings were affirmed today at AAA by Fitch Ratings, which cited the country’s “comparably stronger economic and fiscal performance during the global financial crisis.” The outlook is stable, Fitch said.

The loonie is up 1.8 percent since June 1, the day the Bank of Canada became the first Group of Seven central bank to raise interest rates since July 2008. It increased the rate to 0.5 percent, from a record low of 0.25 percent, and raised it again in July, to 0.75 percent.

The central bank began cutting borrowing costs amid deteriorating financial markets in December 2007 when the policy rate was 4.5 percent. The rate has averaged 2.84 percent over the past 10 years, with a high of 5.75 percent as recently as January 2001, according to data on the central bank’s Web site.

Today’s bank statement “leaves the door open for the Bank of Canada going forward,” Steve Butler, director of foreign- exchange trading in Toronto at Bank of Nova Scotia’s Scotia Capital unit, wrote via e-mail. The statement “is clearly not as dovish as the market expected.”

Bank of Montreal’s Jespersen predicted the currency could strengthen toward C$1.02.

‘Real Stimulus’

“The fact that they’re going to continue probably raising rates is going to be a real stimulus to the Canadian dollar here,” Jespersen said.

Canada’s economy, after growing at an annualized 5.8 percent pace in the first quarter, slowed in the April-June period to a 2 percent rate -- a full percentage point below the central bank’s prediction.

A gauge of Canadian business spending, the Ivey Purchasing Managers Index, climbed to 65.9 last month from 54 in July. The gauge is based on a survey by the Richard Ivey School of Business in London, Ontario. The median forecast of economists surveyed by Bloomberg was for 55.5. Readings above 50 mean purchasing increased.

Building permits in Canada fell 3.3 percent in July, less than forecast, because of a decline in industrial facilities and multiple-unit dwellings such as condominiums and apartments. The total value of permits issues by municipalities decreased to C$6.4 billion ($6.1 billion), Statistics Canada said today in Ottawa. The median estimate in a Bloomberg survey predicted a 4.9 percent drop.