More cuts to interest rate cuts are coming, but inflation concerns are right around the corner says Canaccord Capital analyst Michael Manford.

Manford observes that the U.S. economy “just continues to defy the bears”. While manufacturing is still in a recession, inventories are being eliminated and consumers are holding up. “With the manufacturing area near its bottom, and likely a quarter away from a rebound, real GDP growth should get back into the 2% area in the third quarter and in the 3%-3.5% area in the fourth quarter as the inventory paring subsides.”

Nevertheless, he sees real growth stuck below potential over the next 18 months, as the capital spending and tech areas remain weak. Manford expects another 25 basis point cut to interest rates in the United States to combat the weak growth, but he sees inflation pressure building, noting that productivity is dead and wage pressure is growing. “As this inflation issue unfolds, it will end the Fed easing cycle. Meanwhile, long-term rates face two challenges, inflation and the inevitable easing of liquidity growth.”

This situation should keep stocks stuck in a trading range. “The combination of low interest rates and a flood of liquidity have allowed P/E ratios to expand as earnings have dropped. But, they are at fair value. As the evidence of the rebound in real GDP growth comes in, we expect that earnings expectations will ratchet upward and earnings themselves will rebound in the fall. That should allow the S&P 500 to get into the 1,450 area in early 2002.”

Although the our economy is a bit better, Manford expects much the same to play out in Canada. He sees another 25 bps rate cut, although inflation concerns will begin biting here, too.

“Canadian equity markets are a little cheaper than their U.S. counterparts. However, as commodity prices continue to ease, they are likely to be range bound in the short run. But, Canadian earnings are holding up much better than in the U.S. and even with weaker earnings in the metals and minerals area, we should see earnings up slightly for the year and rise by about 8-10% in 2002. That should get the TSE 300 into the 9,000 area by early 2002.”