Bank of Canada's Next Move?

Lately there has been a slew of good economic data out of Canada. Employment, retail sales, housing starts, you name it, they have all beat expectations this month.

This trend continued today with some surprising CPI data. Core CPI came in at 2.1% versus expectations of 1.7%. For those of you not fully in touch with what's going on up North, allow me to fill you in. On 21 April 2009 the Bank of Canada (BoC) reduced the overnight rate to the effective lower bound of .25% and pledged to keep it there until the end of Q2 2010, "conditional on the outlook for inflation". The BoC also effectively put their money where their mouth was by "rolling over a portion of its existing stock of one- and three-month term Purchase and Resale Agreements (PRAs) into six- and twelve-month terms at minimum and maximum bid rates that correspond to the target rate and the Bank Rate, respectively." Since then, at each Fixed Announcement Date (FAD), the same (now tiresome) message has been repeated. To paraphrase somewhat, it is as follows: 'the outloook for inflation remains steady, therefore we aren't going to hike until the end of Q2 2009, conditional on the outlook for inflation.'

Well, now the game has changed. In their quarterly Monetary Policy Report, published in January, the BoC forecast core inflation to average 1.6% in Q1 and 1.7% in Q2. If this were to materialize, it was implicit that rates would stay on hold. With core CPI in January coming in at 2% and now a 2.1% print in February, this forecast is beginning to look sanguine. The BoC shrugged off higher than expected inflation in their press release after the FAD on 2 March, stating that it was "the result of both transitory factors and the higher level of economic activity". With inflation being more sticky than expected and the next FAD scheduled for 21 April, there should be some vigorous debate behind closed doors at the BoC over the next few weeks. Governor Mark Carney (formerly of Goldman Sachs for all you conspiracy theorists out there) holds the veto at FADs. He is highly regarded in Canada for his handling of the crisis and is surely aware that a lot of the BoC's credibility rests on the right decision on 21 April.


Addendum:
The BoC has repeatedly fingered the strengthening Canadian dollar as a downside risk to inflation. Ironically, traders have been bidding up the Canadian dollar of late in expectation of a rate hike by the BoC. If this momentum trade continues, the feedback on inflation could provide Governor Carney the inflation data necessary to eschew the very rate hike that said traders are looking for.