Bank of Canada Hikes Again As Recovery Takes Hold

Income investing is all about rock-solid stability. And it’s another sign of Canada’s relative strength that the Bank of Canada (BoC) announced another 25 basis point increase to its target overnight interest rate Tuesday morning. This relative strength is a critical factor to consider as you decide how to allocate your investment capital.

Canada was unburdened by a subprime-lending-driven credit bubble, its banks largely avoided risky lending practices, and its government and people have been spared the significant costs associated with patching up holes in too-big-to-fail balance sheets. It entered the crisis on a positive long-term fiscal trajectory, having turned in a decade’s worth of balanced budgets and made slow but steady progress whittling away the federal debt.

The stimulus measures its fiscal and monetary authorities had positive impacts because Canadians weren’t already saddled with debt. What we’re witnessing up north is a normal rebound from what was for Canada a normal recession. What the rest of the developed world is experiencing are the aftershocks of painful deleveraging, counteracted in fits and starts by government efforts to boost demand.

It’s important to remember that the BoC’s latest increase–following a Jun. 3 25 basis point hike–brings its target overnight rate to a still-accommodative 0.75 percent. The BoC notes that the “underlying dynamics” for inflation are little changed, with both the headline and core rates expected to remain near the 2 percent target through the end of 2012. The statement repeats that further rate hikes “would have to be weighed carefully against domestic and global economic developments.”

The BoC revealed a downward revision for its gross domestic product (GDP) growth forecast for Canada, to 3.5 percent from 3.7 percent for 2010 and 2.9 percent from 3.1 percent. It also acknowledged that greater emphasis on balance sheet repair by households, banks and governments in a number of economies could “temper” the pace of global growth it forecast in its spring 2010 Monetary Policy Report.

Though these remain modest steps, and the statement explaining the rate decision remained ambivalent about the durability of the global recovery, Canada at least can acknowledge that the strength of its domestic economy means that the time for extreme monetary measures has expired.

We’ll hear more from the BoC–and get a better feel for its downward revisions for GDP growth when it releases its quarterly Monetary Policy Report on Thursday, Jul. 22. The central bank next speaks on its overnight interest rate Sept. 8.

Income Investing: A Hospitable Locale

Income investing should focus on establishing predictable income streams from solid businesses. This is the bottom-up story. From the top down, it helps to know conditions in the greater domestic economy and at the sovereign level are stable. In other words, balance sheet strength and the ability to grow matter at the company as well as the macro level when it comes to building long-term wealth.

BoC Governor Mark Carney has an entirely different set of problems to deal with than his US counterpart, Federal Reserve Chairman Ben Bernanke. Both have been at the forefront of the global response to the Great Recession of 2007-09, Mr. Carney as the leader of the central bank of the one healthy G-7 economy and a serious player as the G-20 became the primary venue for economic cooperation among nations, Mr. Bernanke as the top monetary policymaker in what’s still the most important economy on the planet. But Mr. Carney is balancing a robust domestic economy against external threats represented by a questionable US recovery and the integrity of European financial systems, while Mr. Bernanke is rumored to be weighing the use of his last available weapon to boost demand, encouraging banks to move excess reserves from their accounts at the Fed to consumers’ accounts by reducing the interest paid on such deposits from 0.25 percent to zero.

Canada remains a relatively small part of the global economic and financial machinery, and much of its status depends on what happens with the Goliath to its south. But over the last decade Canada has separated itself ever so slightly but meaningfully from the US. Though more than 70 percent of its trade is conducted with its southern neighbor, China’s and India’s rapid economic expansions have inevitably meant more use for Canada’s abundant natural resources.

The Canadian dollar weakened following the BoC’s announcement, reflecting traders’ views of what the central bank’s revised GDP growth estimates mean for further rate increases. We’re not long-distance mind-readers, however; our concern is not short-term fluctuations on the currency exchanges. Income investing is all about long-term fundamentals. And the picture in Canada is bright if you’re a US-based investor.

Chinese and Indian demand for oil and other natural resources has boosted Canadian wealth in the aggregate, a long-term trend reflected in the Canadian dollar’s rise from a mid-2004 low near USD0.72 to its present neighborhood in the mid-90s. The persistence of this new Asian demand makes the Great White North the place to be for long-term income investing.

The International Energy Agency (IEA) reported July 19 that China surpassed the US as the world’s biggest oil consumer in 2009. Last year China consumed 2.252 billion tonnes of oil equivalent of energy from sources including coal, oil, natural gas, hydro and nuclear power, about 4 percent more than the US, which had been the world’s biggest energy consumer since the 1900s.

Some observers now describe USD70 per barrel oil as “cheap” and a point on the side of economic bullishness. This reflects the new reality, that oil has achieved a permanently high new plateau range, driven by the emergence of middle-class appetites in a country of more than a billion people.

Look no further for confirmation of this reality than the rampant post-crisis activity focused on Canada’s oil sands regions, at the center of which are several China-linked entities such as sovereign wealth fund China Investment Corp and state-owned entities CNOOC (China National Offshore Oil Company), Sinopec (NYSE: SNP) and PetroChina (NYSE: PTR).

China’s appetites for energy products will only intensify as its economy shifts toward a consumer-demand-driven model. The Middle Kingdom registered record crude oil imports of 5.4 million barrels per day in June, pushing the import share of overall consumption past 50 percent. Crude oil imports are running at an average 4.77 million barrels per day in 2010, up more than 30 percent year over year. Total crude oil consumption was 8.71 million barrels per day, up 18.6 percent year over year.

China has eclipsed the US as the largest automaker on Earth, and it passed Germany as the No. 1 exporter. The energy consumption title is just one more piece of hardware for its expanding collection. And there are more infrastructure projects to be built and consumers to be fed.

The global financial and economic crises that began to unfold in 2007, intensified in 2008 and 2009 and persist in spooking markets today exposed a process that had been underway throughout the first decade of the 21st century.

Only the most basic contours of the new landscape have been revealed, but it’s clear that Canada will be an important part of fueling growth for emerging Asian powers as well as developed ones in its own backyard for decades to come. Successful income investing means having exposure to the high-yielding businesses that call it home.

Editor’s Note: We name names in the Canadian income investing game–check out our recent article Income Investing: How “Low Yield” Can Equal “High Return.