TD Bank predicts that the Bank of Canada will cut rates by 50 basis points in the first quarter of 2004

“It now looks as if the Bank of Canada will be cutting rates again in early 2004 – although this depends crucially on the performance of the Canadian economy over the next two months,” says economist Beata Cranci,. In TD Economics’ Weekly Bottom Line.

Cranci says that this call does not reflect a significant change in its economic outlook. “Instead, it reflects recent statements by the Bank and our belief that this year’s rapid ascent in the Canadian dollar will restrain the pace of economic expansion in 2004 beyond what the Bank is currently estimating. This, in turn, will result in a slower uptake in economic slack than it is currently predicting, which will point to a need for further rate cuts,” she says.

“In the world of [Bank governor David Dodge] and the Bank of Canada, the Canadian economy will expand solidly above potential growth, and therefore there is no need for additional rate cuts,” Caranci says. “We, on the other hand, do not share the Bank’s view that the economy will be able to shrug off the negative impact from the strong movement in the Canadian dollar this year as easily. As a result, we believe the economy will meaningfully underperform the Bank’s expectations with a 3.2% fourth-over-fourth quarter pace of growth in 2004 along with a softer handoff of 4.2% growth in the current quarter. As a result, the output gap will not close until 2005, threatening a delay in the return to the Bank’s 2% inflation target beyond the current estimate of mid-2005.”

Caranci also argues that the central bank’s weighting of risks is too heavily tilted to the upside. It says that it isn’t properly accounting for the fact that the U.S. has more stimulative monetary and fiscal settings, that the U.S. economy should benefit from stronger export growth as its dollar slides, and that the U.S. will receive “another fiscal kick” in the first quarter with more tax rebates.

“The bottom line? We believe the Bank has raised the economic-bar so high, that the Canadian economy will easily slip under it, prompting a 25 basis points rate cut on January 20th and another on March 2nd,” Caranci concludes.