Tripped by Interest Rate Cuts

So, parity was nice, wasn’t it? But the Canadian central bank cut its key lending rate yesterday, mostly prompted by worsening real estate and credit markets in the U.S. (?), as well as due to troubling numbers coming from our own economy (shrinking exports and lower consumer spending). As a result, our soaring loonie was brought down and it is currently trading below parity.

As Camilla Sutton, currency strategist at Bank of Nova Scotia, pointed out in yesterday’s “Globe and Mail,” “Overall sentiment certainly seems to have changed over the last few weeks, moving against the Canadian dollar.” Note that Sutton predicts that our dollar is not likely to remain attractive to domestic consumers at least during December, while she does not count another rally out in the New Year.

It should be said that the Bank of Canada’s top man, David Dodge, has always been wary of the risk components in the U.S. spilling over into global markets. Dodge long ago pointed out the dangers of the deteriorating U.S. housing market and the far too tight credit conditions. In addition, Canadian economic data, such as lower inflation and the domestic currency being out of control, only “cemented” the deal.

The bank further said that, “The bank judges that there has been a shift to the downside in the balance of risks around its October projection for inflation through 2009. In light of this shift, the bank has decided to lower the target for the overnight rate.”

Moreover, it seems that Tuesday’s interest rate cut is not likely to be an isolated “incident.” Stewart Hall, market strategist at HSBC Securities (Canada) commented, “The door is open to further rate cuts, although it is not a fait accompli at this particular point in time.”

Although it is widely expected that the Federal Reserve already has and will continue to have a more aggressive approach to interest rate cuts than Canada’s central bank, still, more rate cuts by the Bank of Canada could also in the cards for Canadians.

I have to say that, although I expected one more interest rate cut by the end of 2007, based on Dodge’s previous comments, I would be surprised if he decides to keep on cutting key rates, regardless of how much slower in comparison to the Fed. Dodge has been very critical of the Fed’s policy to fight market downturns with easy money and the recent credit crisis only proved his point.

Dodge was also always wary of the possibility that government policies may overshoot their landing, resulting in pushing the economy a bit too much in the right direction. After all, investors and other market participants already know that there is such a thing as “too much of a good thing.”