Threat is higher for the U.S. than for Canada

    TORONTO, April 6 /CNW/ - CIBC (CM: TSX; NYSE) - Canada appears likely to
adopt a much milder version of the U.S. and U.K. strategy of printing more
money to fight the recession, a tricky measure that risks high inflation, or
even hyperinflation down the road, notes a new report from CIBC's wholesale
banking arm.
    "Printing money looks to be a key ingredient in preventing a global
recession from tipping into a lasting depression," says Avery Shenfeld, chief
economist, in his latest report.
    "A more aggressive monetary posture today should presumably hasten an
economic recovery, and diminish the odds of an extended disinflationary
period. However, it also raises the risk that policy makers will mishandle the
timetable for unwinding unprecedented amounts of fiscal and monetary stimulus,
leading to run-away inflation," notes Mr. Shenfeld.
    Printing money - formally known as quantitative easing - is a strategy
where central banks use newly created money to buy government bonds that
finance spending programs. Those extra dollars in the economy spur growth but
can also shrink the buying power of each dollar, which is the definition of
inflation.
    "Excessive inflation is indeed a hazard after a winning battle against
deflation," says Mr. Shenfeld who believes inflation risks are greatest south
of the border. With the U.S. "facing a sharp climb in government debt and a
household sector similarly over-borrowed, inflation could be a tempting way to
shrink the real value of those burdens. And even without a deliberate plan, it
would be easy to err and unintentionally overdo the money pump-priming, or
reverse it too late."
    Bank of Canada (BoC) Governor Mark Carney has downplayed expectations
that the Bank will implement quantitative easing in April, Mr. Shenfeld notes.
But "considering the deteriorating economic outlook, and with core inflation
set to drop below the 1-3% band by late this year, further monetary stimulus
will be required."
    Rather than announce an overnight interest rate cut in isolation, Mr.
Shenfeld expects the BoC will "stand pat" in April and launch a
Canadian-styled quantitative easing or credit easing program within the next
three to six months. Canada's "gentler" approach will entail buying government
bonds or other credits to lower longer term interest rates, while taking steps
to neutralize the impact on money supply growth and overnight interest rates.
    "The BoC is much more committed to its strict inflation target. And
Canada's government debt burden, while again on the rise, will still be much
lower than Washington's, creating less of a temptation to simply inflate it
away. Even so, Governor Carney will have his work cut out for him as he
attempts to keep yields and long-term inflation expectations down with money
supply growth already on steroids," says Mr. Shenfeld.
    If the Bank of Canada goes down the path of quantitative easing and a
recovery takes hold, the first dose of monetary retightening will not be an
overnight rate hike but more likely entail reversing the BoC's asset purchases
by selling bonds back to the secondary market, says Mr. Shenfeld.
"Anticipating that response, we've pushed back any Bank of Canada overnight
rate hikes beyond our end-of-2010 forecast horizon."
    Mr. Shenfeld adds that "even if a spike in inflation doesn't materialize
in the U.S., monetary retightening will be accompanied by substantially higher
rates across the curve, as the Fed unwinds its balance sheet moves by selling
bonds that it accumulated under a monetization mandate. That has us retaining
our bearish view on long bonds, particularly Treasuries, with Canadas set to
outperform. Meanwhile, to the extent that loose global monetary policy,
including quantitative easing, boosts inflation concerns, that should be a
positive for a commodity-linked currency like the Canadian dollar farther down
the road."
    Elsewhere in the inflationary-themed report, Senior Economist Benjamin
Tal writes that a recovery in oil prices beyond 2010 will heighten already
soaring food inflation and force a fundamental change in agriculture and food
systems.
    "The foundation of the modern agri-food system has rested on cheap
energy, given the need to maximize yields in the face of constraints on arable
land supply. But a recovery in oil prices, and the potential impact of
environment policies to restrain its use, will turn this model on its head,"
he says.
    "The current disconnect between food inflation and overall inflation is
an early sign of the upcoming changes in the economics of food. While fuel
prices will remain subdued through 2010, a global recovery will have them
rising more materially again beyond then, particularly if carbon taxes or
emissions permits are imposed. In an effort to reduce energy intensity,
farmers will increase organic food production whereas the food system as a
whole will reduce its dependency on imports, and will become much more
localized."
    The complete CIBC World Markets report is available at:
http://research.cibcwm.com/economic_public/download/sapr09.pdf

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