Wednesday Night #1097 Jacques Clément Report

Jacques Clément’s Report on Economic and Financial Developments

Canada:
Inflation rose by almost 1% in January (4½% year/year), caused mainly by increases in automobile insurance premiums, vehicle prices, real estate taxes, rents, energy and other services. With core inflation at 3.9%, Canada’s inflation is 2% above that of the United States. The Bank of Canada’s core, which excludes the eight most volatile components, namely fruits, vegetables, gasoline, heating oil, natural gas, interurban transport, tobacco products, interest on mortgage loans and indirect taxes on all components, rose by 3.3%.

Given the likelihood of increased numbers in the March 21 release of the Consumer Price Index, I look for the Bank of Canada to increase its overnight rate by ¼% to 3¼% at its April 15th meeting.

The Canadian economy is running at full steam and is outperforming that of the U.S. Employment and housing investments are at record levels. The trade surplus in January was close to $5B, with renewed demand for exports. The manufacturing sector remains fairly strong, with capacity utilization close to 83%. Leading economic indicators have increased for the eighteenth consecutive month. The economy is operating close to its non-inflationary potential.

The Canadian dollar, after trading at sixty-eight and a half cents U.S. and dropping to 67 3/8, could rebound to sixty nine cents by mid-April, given wider interest-rate differential favouring Canada over the U.S. and Europe, the sign that Canadian pension funds appear to be close to their target on adjusted foreign assets contents, Ottawa’s sixth consecutive year of fiscal balance and surplus, the best fiscal and economic performance of the G-7 in 2002 and likely again this year. With close to forty-eight billion repayment, the outstanding debt of 508 billion is down to 44% of the G.D.P. from 67% in 1995-96.

The U.S. Economy:
The Federal Reserve at its Federal Open Market Committee (F.O.M.C.) meeting of March 18, is likely to leave policy unchanged, with federal funds at 1¼%, but moving back to an easing bias in order to ease policy by ¼% at the meeting on May 6. Given the lag between the two meetings, and the very sluggish state of the U.S. economy, they could even decide to move to a new forty-five year low as early as next week.

With the loss of over three hundred thousand jobs in February, auto sales declining by 14%, very weak consumer spending, ten-year low in consumer confidence, the decline of fifteen percent in new home sales, renewed weakness in retail sales and services, business spending continues to lag and economic growth is being revised down to as low as 1½% for the first half. Non-farm productivity has receded significantly in the fourth quarter. The (US)$435B trade deficit last year was its largest in history, as was the current account deficit.

The record fiscal deficits of over $300B for fiscal years 2003 and 2004, will lead to higher interest rates after fifty-year lows. Manufacturing has dropped in February for a fourth month in six.

The only positive developments are the continuing rise in personal income, the strength in existing home sales, the rise of 5% in housing starts (Jan. And Feb.) and the rebound of exports in January.

After four-year lows in the U.S. dollar, it has recovered slightly. The euro traded at $1.10 U.S. and could trade at $1.15 by mid-year. Gold traded at $383 U.S. on February 4, a 6.5-year high and could recede to (US)$325, with central banks renewed selling (Bank of Canada sold 15% of its reserves in February).

Oil prices which touched almost $38 U.S., a twelve-year high, are likely to ease to (US)$30-$35 in the coming weeks.