The Bank of Canada should give some thought to skipping a December rate hike suggests a new report from BMO Nesbitt Burns.

“With the marked decline in the Canadian trade surplus in September and the slowdown in manufacturing shipments, the Bank of Canada might well be becoming wary of the continued rise in the Canadian dollar,” Nesbitt chief economist Sherry Cooper writes in the report. She adds that, “the export sector will continue to be challenged by the 35% rise in the loonie since early 2002”.

Cooper notes that consumer confidence is near a 14-year high. “But, it is clear that the double whammy of a large U.S. budget deficit and a record U.S. trade and current account deficit argues for a further fall in the U.S. dollar,” she warns.

Indeed, in a speech today to the European Banking Congress in Frankfurt today, U.S. Federal Reserve Board chairman, Alan Greenspan, said, “Net claims against residents of the United States cannot continue to increase forever in international portfolios at their recent pace. Net debt service cost, though currently still modest, would eventually become burdensome. At some point, diversification considerations will slow and possibly limit the desire of investors to add dollar claims to their portfolios.”

Currently, Asian economies are holding the bulk of their foreign exchange reserves in U.S. dollars, essentially recycling their large U.S. trade surpluses back into the U.S. Treasury market, Cooper explains, and “helping keep American interest rates low by funding the deficit and supporting the dollar.”

“But very recently, China has apparently been diversifying away from U.S. Treasuries and Japan has not intervened in favour of the U.S. dollar since March of this year,” she notes. Japan is by far the largest net buyer of U.S. Treasuries, Cooper says, followed by the U.K., Caribbean Banking Centres (which are largely hedge funds), and then China (whose net purchases represent less than 10% of Japan’s). While foreign central bank purchases of U.S. Treasuries continue to grow, private buying has slowed significantly, Cooper notes.

“International investors will eventually adjust their accumulation of dollar assets or, alternatively, seek higher dollar returns to offset concentration risk, elevating the cost of financing of the U.S. current account deficit and rendering it increasingly less tenable,” Greenspan said.

“But it is in no country’s interest to dump Treasuries because it would ensure that U.S. rates would rise sharply, slowing American demand for imported products and likely triggering a worldwide recession,” Cooper says. “This is a very difficult balancing act. China will likely succumb to pressure to gradually revalue.”

“The Bank of Canada, in this environment, would do well to consider the efficacy of continued rate hikes. At the very least, they should consider sitting out the December move, if for no other reason than to let the dust settle on the slowdown in Canadian net exports to the U.S.,” Cooper counsels.