My Two Cents on Interest Rates!

In a recent speech to the Montreal Board of Trade, Governor of the Bank of Canada, David Dodge, said that Canadians should not panic upon hearing isolated and disconcerting pieces of economic data. He offered reassurances that our economy is plugging along just fine, primarily because seven consecutive interest rate increases have done the job of keeping inflation in check.

However, even an optimistic Mr. Dodge had to acknowledge that when market volatility is translated into specific economic data, sometimes market watchers simply don’t know what to make of it. Crossed wires provide for a very confused forecasting environment, to say the least.

The next time Canada will be observing changes in interest rates is July 11. When the Bank of Canada last increased interest rates, economic indicators were all out of whack. Regardless, at the time, the overall impression was that going forward, rates should remain pat. Why? Well, according to Mr. Dodge, in spite of economic data often pouring out from opposite sides of the spectrum, the overall economy somehow managed to balance itself out.

On the other hand, the market and economists have had little fate in this balancing act. In their view, the scales seem to have tipped over towards stronger performance. To illustrate, for the first quarter of 2006, Canada’s GDP stood at 3.8% annually, which was better than anyone had expected. In my previous commentaries I also mentioned Canada’s unemployment rates, which have dropped to new lows, while job creation became comparable to a volcano eruption.

As a result, inflation showed it has a pulse. This is why many market watchers are questioning Mr. Dodge’s statements that Canada’s economic universe is at peace and that there is no need to raise interest rates come July.

Here comes my two cents on interest rates, for what it’s worth, although I typically try not to get into that game. More often than not, it is darned if you’re right and darned if you’re wrong.

Anyhow, I believe interest rates are an outdated way of keeping inflation in check, and, by extension, restraining the economy from getting too hot. Stock markets have been doing quite an alright job at that. This is why rates should not go up in July, if, for no other reason but to stop sending contradicting signals to the already tired audience.

Also, although I think that Mr. Dodge is a man of his word and that he’ll keep interest rates the same in July, he’ll be doing it for the wrong reasons. Central banks’ managers still believe the world revolves around their little back rooms and handshake deals. Well, it doesn’t!

With the new millennium, world economies and world markets have grown up and taken on identities of their own. The game has changed, though whether for better or for worse, remains to be seen. The rules of the game have also changed. And, the sooner people controlling our wallets realize that, the sooner we can all start adapting to new realities.