Inflation worries will drive interest rates higher
Globe and Mail Update
May 5, 2008
JOHN PARTRIDGE
Unrelenting upward pressure on food and energy prices will force the Bank of Canada to reverse course and start raising interest rates to combat inflation over the next year, a high-profile Bay Street economist says.
"While the Bank of Canada may still deliver another rate cut, reflation will compel it to raise interest rates by at least 100 [basis points] next year," Jeff Rubin, chief economist and chief strategist at CIBC World Markets in Toronto said in a monthly report on portfolio strategy.
The central bank has cut its key overnight lending rate to 3 per cent, down by 1.5 percentage points since last fall.
What is more, Mr. Rubin said he now expects U.S. federal Reserve Board chairman Ben Bernanke, to stop their rate-cutting drive when the key U.S. rate hits 1.5 per cent, rather than 1.25 per cent as CIBC previously forecast.
The fed cut the benchmark federal funds rate by 25 basis points to 2 per cent last week, bringing to 325 basis points the cutting it has done since last summer in a bid to limit economic damage from the U.S. housing and credit crises. (A basis point is one one-hundredth of a percentage point.)
As a result of the consumer price index inflation rate being set to "almost double next year," Mr. Rubin said the firm is exiting its over-weight position in bonds and moving two percentage points of weighting to equities and the other two points to cash. This leaves it with 55 per cent in stocks, 38 per cent in bonds and seven per cent in cash, he said in the report.
"Moreover, we anticipate that we will be moving further assets out of our fixed income portfolio, as well as shortening duration in that portfolio as our forecast of rising inflation pans out," Mr. Rubin said, adding that markets will be "surprised at how rapidly" the central bank will be "compelled to take back" its rate cuts next year.
Within equities, Mr. Rubin said the firm is adding an additional percentage point to its already over-weight position in the energy sector, taking the total to 37.1 per cent.
It also is adding 0.5 percentage points to its weighting in the materials sector, taking the position to 20.4 per cent of the portfolio, with the additional weighting focused on agricultural chemicals.
To compensate, the firm is trimming utilities by 1 percentage point to 2.5 per cent, while cutting back the consumer staples weighting by half a point to 2.2 per cent, "particularly in food retailers and processors, whose margins are getting decimated by soaring food costs," Mr. Rubin said.
