The Bank of Canada (BOC) interest rate hike is inspiring a bullish outlook among industry experts, who consider it a sign that Canadian economy is on solid footing.
There does, however, seem to be some concern over uncertainty of future action.
“A modest interest rate hike may be viewed as bullish from the equity market,” says Darcy Briggs, co-lead manager for the Bissett Canadian Short Term Bond Fund. He says an isolated interest rate hike would not have a big impact. “It’s a sustained trend in interest rate hikes that would affect various asset classes.”
The Bank of Canada has left the door open in terms of further action. “There is a degree of uncertainty that the markets will have to deal, which could lead to increased volatility,” says Briggs.
Similar concerns were raised by Kate Warne, market strategist, Edward Jones. “The BOC has raised some uncertainty about whether we’d see more or how many more (rate hikes).”
Warne, though, says the hike as it stands means very little for Canadian equity investors because it was widely expected. “Most investors had anticipated that either today or in July the BOC would increase rates.”
The Canadian economy grew at an annualized rate of 6.1% in the first quarter, and today’s rate hike appears to be confirmation that the economy will remain quite strong. It also indicates that the Bank of Canada is confident it will continue to grow, says Warne who finds the rate hike somewhat comforting, especially for investors in fixed income.
“I think the BoC’s decision to move should somewhat reassure investors in fixed income that [the Bank] is sensitive to worries about rising inflation and that they are not going to allow inflation rates to increase insofar as they can control them by slowing down economic growth,” says Warne.
She says there may be a bit of increase in interest rates paid on cash, but nowhere near investor expectations. “Any increase in short-term rates is likely to lead to slightly higher rates on cash, although they still will remain extraordinarily low compared to what investors would like to get.”
It is a different ball game, though, when it comes to equities, which Warne says are not that strongly tied to rate hike. “Usually there is less contention between Canada rate hikes and equity investors, but historically equity investors have continued to do well in the early parts of the rate-raising cycle.”
Strong economic growth and strong earnings growth are much bigger driving factors than rate hikes, she says.
The Canadian dollar will likely remain unaffected, as the anticipation of hike had already pushed it toward parity. “If it’s a one-and-done [hike], it will probably have a negligible effect,” says Briggs. However, the loonie later pulled back when it became apparent that the central bank may not continue to raise rates given the uncertainty in the global economy, says Warne.
A shallow recession and a speedy recovery from it are factors attributed to Canada being the only country in the G-7 to announce a rate hike.
“Overall, the Canadian economy is in a much better position than the other G-7 members,” says Warne, adding that none of the others are in a position to tighten monetary policy.
Briggs agrees. “Canada’s economic performance has been a rapid improvement out of the recessionary environment.” He credits the domestic property market as the engine that pulled Canadian economy to safety. It is the relatively “unabated consumer spending on real estate (that) has helped power the Canadian economy, whereas the housing market is in doldrums in other G-7 countries.”
(06/01/10)