Low interest rates may be with us for a while, possibly for the rest of the year, as the North American economies struggle to get back on their feet, two economic reports predict.

BMO Nesbitt Burns Inc. chief economist Sherry Cooper noted today that, with the Toronto economy suffering from SARS and the national economy under the cloud of a stronger dollar, the Bank of Canada did the expected and held off on another rate hike.

“The stronger loonie has done it for them,” said Cooper. “Moreover, the marked reduction in the April inflation numbers clearly signals that the Bank could well remain on the sidelines for the rest of this year. Indeed, some would argue that a rate cut is in the offing by the Bank of Canada, although that appears relatively unlikely at this stage.”

CIBC World Markets said this week the central bank has dropped its tightening rhetoric, but still seems a bit behind the curve on what lies ahead for the Canadian economy. “While Canada’s days of steadily outperforming the U.S. economy are over, the Bank will likely stand pat on rates, allowing Canadian-U.S. bill spreads to balloon even further,” CIBC says.

Copper said it is a different story in the U.S. “Rather than inflation fear, it is deflation fear that is driving the Federal Reserve. The May Fed statement signaled a willingness to ease again if core inflation trended downward and the level of economic activity remained sluggish,” she said. She says that the data released since then suggest a 50 basis point rate cut should be on tap for the June 24-25 policy meeting.

“That would take the overnight federal funds rate down to a mere 75 basis points, its lowest level in 45 years. Imagine that.” Cooper said. “At that diminutive level, money market mutual funds would have trouble paying anything on invested balances, as fees would more than consume the pint-sized returns that could be earned on short-term investment portfolios.”

Cooper noted that the Fed has also mused that they might consider more unorthodox measures to boost the economy. “Rather than rely on the short-term end of the yield curve, they might buy bonds instead, further driving down already low longer-term interest rates.”

There may well be political pressure for the Fed to act, Copper said. “President Bush has already suggested that he would reappoint Sir Alan [Greenspan] to yet another term as Fed Chairman, making him the first octogenarian governor in history. So Greenspan will feel no small pressure to give the U.S. economy (and the President) whatever juice it needs.”


CIBC concurred, noting, “The Fed is beginning to learn that it wasn’t Iraq that kept payrolls falling and business investment nowhere to be seen. And President Bush knows it won’t be Iraq that voters will be judging him on next year. It’s time for the Federal Reserve Board to get back into action, with a quarter point cut at each of the next two meetings of the FOMC.”

As for stock markets, CIBC says that currency effects will boost S&P 500 earnings but materially dampen TSX earnings.

BMO says that in the U.S., the weaker dollar and stronger productivity numbers have been driving big gains in the stock market. “Since the stock market lows posted in early October, the Nasdaq is up a whopping 43%, the S&P 500 has boasted a 24% gain and the Dow and TSX have risen 20%, well outpacing the 5%-to-6% rise in U.S. and Canadian bond values. The stock markets are clearly forecasting a reviving U.S. economy, where deflation is a minor problem if it is any problem at all,” Cooper says. “But the jury is still out on that one. For now, American business remains very cautious, layoffs continue and jobs are hard to get.”