For six months, Nicholas Bianchi and his wife, Jeannette, have been searching for a house in central Toronto. But until last week, they were in no hurry to buy. What changed their minds was Bank of Canada governor Gordon Thiessen’s decision to raise short-term interest rates by a quarter of a point to 5.5 per cent. With more increases apparently on the horizon, consumers may soon be scrambling to lock in their mortgages and loans. Said Nicholas Bianchi: “Now, I feel pressured to buy a house, just so we can beat the next interest rate increase.”
Normally, interest rates rise when investors fear rising inflation, but that is not the problem now. Instead, the Bank of Canada’s move last week was intended to prop up the Canadian dollar, which has been sideswiped by turmoil in Asian financial markets. In recent weeks, currency traders have aggressively sold off the dollar in the belief that Canada’s resource exports will suffer as demand shrinks in Asia. Already, there have been widespread layoffs in the British Columbia lumber industry, and Japan’s steel producers are now demanding a cut in the price they pay for Canadian coal.
Several times this fall, Thiessen has threatened to raise rates to slow Canada’s economic expansion, which he believes is unsustainable and could eventually lead to higher inflation. International currency
traders point out that Canada’s prime rate, at
5.5 per cent, is well below the U.S. prime at
8.5 per cent, a gap that benefits consumers but encourages investors to look south for higher returns. As the Asian currency crisis flared over the last two months, the central bank acquired two more compelling reasons to raise rates. Investors dumping their holdings in that part of the world are buying the U.S. greenback, pumping up its value against the Canadian dollar. At the same time, the slumping demand for raw materials in Asia adds to the downward pressure on the currency.
Speaking to the House of Commons finance committee last week, Thiessen made it clear that he would raise rates again before letting the dollar slip below the psychologically important 70-cent (U.S.) barrier. His concern is that a lower dollar would stimulate even more growth in the economy, which he says is already booming, while making imports more expensive. Canada, Thiessen added, “does not need more stimulus from further weakening in the currency.”
With the debacle in Asia spreading, economists say it may take more than a quarter-
point increase to keep it above its all-time low of 69.2 cents, set in February 1986. In fact, after a brief rally following last week’s interest rate boost, the dollar finished the week virtually unchanged at 70.23 cents. ‘The Asian crisis has only made matters worse,” said Andrew Pyle, chief economist at Toronto-based ABN AMRO Bank Canada. “Rate increases are going to be significant and abrupt.”
The irony is that Thiessen may find himself raising rates even as the Asian meltdown slows the domestic economy and further dampens inflationary expectations. Until the Asian crisis, economists were predicting that Canada’s gross domestic product would increase by about 3.2 per cent in 1998, creating 275,000 new jobs. But last week, analysts were scrambling to adjust those figures downward. If the meltdown pushes Japan into a full-blown recession, they say, it could slice a full percentage point from Canada’s GDP and push the unemployment rate back over 10 per cent. “People have not yet come to terms with the full impact of the Asian monetary crisis,” said Patti Croft, chief economist at Torontobased Sceptre Investment Counsel Inc. “The ¿ big question is, what will it do to the engine 5 of growth, the U.S. economy?”
I In Canada, the Asian shakedown has pri£ marily hurt raw material exports, but a numd ber of small manufacturers have also been £ hit. Last summer, Viceroy Homes Ltd. of Toronto opened a plant in Vancouver to produce prefabricated houses for the Asian market. The strategy was paying off, with Japan accounting for as much as 62 per cent of Viceroy’s sales. But when the slumping yen made imported homes more expensive, the market collapsed and profits fell 30 per cent to $1.8 million in the first six months of this year.
A similar fate has befallen the B.C. resource sector. In 1996, Asia bought 37 per cent of the province’s exports—primarily pulp, paper and softwood lumber. Japan alone consumed almost half the province’s total lumber exports last year, worth $2.5 billion. But construction in Japan has slumped, with the result that dozens of lumber mills have closed across the province. Coal exports will also be hurt. In 1996, Japan’s steel industry imported 13.9 million tonnes of metallurgical coal, or about half the country’s total exports. Squeezed by falling demand for steel, the industry is now demanding a five-percent cut in coal prices. Coal producers may have little choice but to do what Gordon Thiessen did last week when faced with pressure for higher interest rates: give in.
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