Category: Canada

Bank of Canada raises rates a quarter point

The Bank of Canada, to nobody’s surprise, raised interest rates by 0.25% today. Key parts of their statement:

Economic activity in Canada is unfolding largely as expected, led by government and consumer spending. Housing activity is declining markedly from high levels, consistent with the Bank’s view that policy stimulus resulted in household expenditures being brought forward into late 2009 and early 2010. While employment growth has resumed, business investment appears to be held back by global uncertainties and has yet to recover from its sharp contraction during the recession.

The Bank expects the economic recovery in Canada to be more gradual than it had projected in its April MPR, with growth of 3.5 per cent in 2010, 2.9 per cent in 2011, and 2.2 per cent in 2012. This revision reflects a slightly weaker profile for global economic growth and more modest consumption growth in Canada. The Bank anticipates that business investment and net exports will make a relatively larger contribution to growth.

…

Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.

The take-home message is that growth projections have moderated to a “business as usual” type of economy after the 2008 calamity and the Bank of Canada is reserving all rights to not committing themselves to future rate increases. It is likely the global situation, rather than the domestic situation, will have significant influence over the decision to continue to raising rates.

As of today, the target rate is 0.75%, and I expect a rate of 1.00% by years’ end.

The only implication of this decision is that short-term corporate paper and inter-bank lending rates will correspondingly increase. People with variable rate mortgages will see interest increases, but this will not be affecting the longer-term fixed rate mortgage rates. The other subtle implication for most people is that financial institutions such as ING Direct might be willing to offer better rates on short-term savings and/or short-term GICs.

Bank of Canada Interest Rate Projections

On July 20, the Bank of Canada is very likely to increase the overnight target interest rate from 0.50% to 0.75%; this has already been baked into the marketplace. The Prime Rate is likely to correspondingly increase from 2.5% to 2.75%.

In terms of what lies ahead in the future, we look at the only financial product in Canada that one can use to predict such rate changes, the 3-month Bankers’ Acceptance Futures:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 JL 0.000 0.000 99.045 0.030 0
+ 10 AU 0.000 0.000 98.960 0.030 0
+ 10 SE 98.875 98.880 98.880 -0.005 10612
+ 10 DE 98.700 98.710 98.710 -0.010 20474
+ 11 MR 98.540 98.550 98.540 0.000 17714
+ 11 JN 98.350 98.360 98.360 0.000 10038
+ 11 SE 98.140 98.150 98.140 0.080 2281
+ 11 DE 97.890 98.110 97.890 0.080 209
+ 12 MR 97.580 97.700 97.680 0.000 341
+ 12 JN 97.370 97.490 97.430 0.090 0

What we see is a 3-month future rate of 1.12% in September; and by years’ end we have a 1.29% rate.

There are four more meetings left in 2010; July 20, September 8, October 19 and December 7.  Right now, the market is speculating that there will be 0.25% increases in two of these meetings, leading to a year-end target rate of 1.00%.  It is possible that after September 8, that the Bank of Canada will leave short term rates unchanged for the duration of the year.

In 2011, the market believes that the short term rate will increase by about 0.75% above this; to 1.75%, still a very low rate by historical standards.

Presumably after its July20 statement it will change the language which will sufficiently guide the marketplace to adjust its prices.

Of note is the impact on mortgage rates; only variable-rate mortgages will be going up as a result of these short-term rate increases.  The reason is because longer-term rates are set by the marketplace, and these have gone down over the past quarter.  A 5-year government bond yields 2.49% currently; this was as high as 3.2% back in April.

CRA Prescribed rates for Q3-2010

Thanks to the comments from Jeff Usher, it appears my initial thoughts about the CRA prescribed rates were incorrect. I consider myself well-researched in these matters, but once in awhile, things slip and this was one of them. Thank you Jeff.

The CRA, on June 28, 2010, published the third quarter prescribed rates.

Apparently the reason for the delay is that Bill C-9 implemented a reduced rate of accrued interest for corporate overpayment of tax. Corporations were using the CRA as a savings account, where they were getting higher rates of interest than the banks. In the previous quarter, this amount was 3%, but going forward it will be 1%.

Canada Pension Plan not happy with Magna

Magna International is a dual-class stock that retained control of the corporation in the Stronach family.

The Canada Pension Plan is unhappy that the corporation recently agreed to a deal with the Stronach trust to convert their class of voting stock into regular common stock, at a very high premium – $300 million in cash, plus 9 million class A shares. At today’s prices for class A shares, this works out to approximately $920 million in exchange for the voting rights of the company.

Suffice to say, shareholders are not too happy about the matters, including the Canada Pension Plan.

However, this should be a huge lesson to those that invest in majority-controlled companies – your interests have to line up with the interests of the majority holder in order for you to make any headway on your investment. In the case of Magna, its majority holder (Stronach) clearly wants as much cash and liquidity out of the corporation as possible – and the common shareholders, including those invested in the Canada Pension Plan, will be paying the price.

What is interesting, however, is that the deal was structured in a politically astute manner – common shares went up after the announcement since Magna was already trading at a discount due to the adverse interests of the majority holder. It is the company, however, that will be paying the price to buy out the Stronach voting stake.

If you have shares in companies that are majority controlled, pay careful attention to these agency issues.

Summer Markets

Readers here might have noticed a lull in posting over the past week – it’s because I’ve been on a break and will continue to be so until mid-July.

A good deal of people on Wall Street take some part of the summer off – especially the month of August. Trading, as a result, becomes dominated by computer trading and volatility is typically higher due to decreased market volumes.

This last quarter has been quite dull on the trading front, but as the markets continue to dive, I am watching for opportunities.