Question

The Canadian dollar strengthened against its U.S. counterpart on Tuesday as oil prices rose to 3-1/2-year highs and domestic manufacturing data supported the view that the Bank of Canada will hike interest rates next week. At 4 p.m. EDT, the Canadian dollar was trading 0.4 per cent higher at $1.3138 to the greenback, or 76.12 U.S. cents. The currency traded in a range of $1.3133 to $1.3207. Growth in the Canadian manufacturing sector accelerated in June to its fastest pace in more than seven years, data showed. The IHS Markit Canada Manufacturing Purchasing Managers’ Index rose to a seasonally adjusted 57.1 last month from 56.2 in May. Strengthening of domestic data has come despite slow-moving talks to revamp the North American Free Trade Agreement and a trade dispute with the United States. The White House said on Monday that Canada’s decision to enact tariffs on $16.6-billion worth of American goods in retaliation for U.S. tariffs on imports of Canadian steel and aluminum would not help its economy. “We have been climbing the wall of worry since April and the manufacturing sector in Canada is still posting multi-year strength levels,” said Michael Goshko, corporate risk manager at Western Union Business Solutions. “The Bank of Canada has got to pay attention to something like that.” Perceived chances of an interest rate hike at the July 11 announcement have jumped to nearly 80 per cent from about 50 per cent before hawkish comments by Bank of Canada Governor Stephen Poloz at a news conference last week. On Friday, when domestic data showed a surprise expansion of the domestic economy in April and business optimism, the loonie touched its strongest in two weeks at $1.3131. U.S. crude oil futures settled 0.3 per cent higher at $74.14 a barrel. Oil is one of Canada’s major exports. The U.S. dollar fell nearly 0.5 per cent against a basket of major currencies ahead of the July 4 Independence Day holiday, while stocks on Wall Street were pressured by declines for technology stocks. Canadian government bond prices were higher across a flatter yield curve, with the two-year up 2.5 Canadian cents to yield 1.898 per cent and the 10-year rising 22 Canadian cents to yield 2.142 per cent. The 10-year yield touched its highest intraday level since June 18 at 2.204 per cent. Canada’s employment report for June and trade data for May are due out on Friday. Relating your argument to the material we have covered in the class and using the information about the situation in the Canadian economy from the article, explain why it is expected that Bank of Canada will be increasing the interest rate soon.

Answer 1

Any central bank increases interest rates when it sees that the economy is showing signs of a pick up and when they expect inflation to be on the rise because of higher demand. Thus in order to reduce money supply, the central bank will increase the interest rates so as to pull the money back into the system, which avoids the chances of inflation increasing beyond expectation.

Canadian dollar has strengthened against USD, and oil prices rose which signifies increase in fuel inflation and manufacturing has picked up which implies that demand is on the rise. So people are going to spend more. Additionally as oil prices have increased, exports are expected to rise which will lead to higher output and more earnings. Plus whenever investors expect the economy to pick up, government yields increase which has occurred over here as well.

Thus as the overall macroeconomic situation is expected to improve, the interest rate is expected to increase because of increasing demand and pick up in output. The central bank had lowered interest rates to a great extent in March, turning it close to 0%, this leaves room for the central bank to increase the interest rates now that economy is showing signs of a pick up in demand and output.