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david rosenberg

There is some expectation that the U.S. Federal Reserve's policy-making committee will drop or change the words "exceptionally low" and "extended period" when it issues today's statement on interest rates.

My hunch is that the Fed will do the right thing and refrain from making significant changes to its wording - the recovery is still far too fragile and reliant on government-applied steroids. It would be a mistake, in my view, to prep the markets for an early rate hike. Of course, that didn't stop the Bank of Canada from doing that very thing in its last statement.

With barely more than three months left before the apparent expiry date on a policy that had been in place for almost a year, it was time for Canada's central bank to either brace the markets for the possibility of a no-move beyond June or start ratifying what investors have been discounting for some time now.

The bank chose the latter, and this means that we have to pay heed - the odds of higher short-term rates (not good news for domestic retailers), a flatter yield curve (not good news for banks) and a stronger loonie (not good news for exporters) ahead have taken a giant leap forward.

But consider for a moment: The Bank of Canada has never successfully embarked on a tightening course in advance of the Fed.

The one time it did try to get the ball rolling first - something it tried close on the heals of an annualized 5 per cent quarterly bump in GDP growth - it was a mistake of historic proportions.

What I am talking about was the aborted move by the bank to raise rates in the spring and summer of 2002 in the very early stages of the post-tech-wreck healing phase, only to then see the Fed ease policy in November, 2002, and again in June, 2003. The Bank of Canada was then forced to reverse course.

In fact, the Bank of Canada policy rate, which had been boosted from 2 per cent to 3.25 per cent in 2002-03, was eventually cut all the way back to 2 per cent in early 2004.

It is eerily similar. The bank's March 5, 2002, press release prepped the market for a rate hike by saying "the overall pace of economic activity in Canada and the United States has been stronger than expected, confirming that a recovery is under way." Then when it began to raise rates on April 16, we were put on notice that "the accumulated information since the beginning of the year continues to indicate stronger-than-expected economic growth in Canada and the United States. A robust recovery appears to be under way in Canada."

The Bank of Canada kept raising rates while the Federal Reserve was still worried about the U.S. macro outlook. Then, all of a sudden, what was a 5 per cent growth quarter to kick off the Canadian tightening cycle morphed into a subpar 1.7 per cent trajectory just four quarters later.

It was not long thereafter that the mea culpa of mea culpas was issued - as it prepared to unwind all the rate hikes of 2002 and early 2003, Canada's central bank notified us that: "There have been a number of unanticipated developments that bear on the outlook for inflation and economic activity in Canada. Both inflation and inflation expectations have declined more rapidly than the bank had expected. ... Foreign demand for Canadian products has also been weaker than earlier anticipated. In addition, the rapid and sizable appreciation of the Canadian dollar against the U.S. currency will tend to have a dampening effect on the demand for tradable Canadian goods and services."

Many pundits today retort that we have emergency interest rate levels and yet the emergency has passed. This is circular reasoning because a key reason why the emergency has passed is because the bank (and the Fed) kept rates at extremely low levels. If you go back to 2002 when the policy rate was 2 per cent, it too was at an emergency level.

The bottom line is that emergency interest rates have given Canada one quarter of solid growth after an unprecedented eight quarters of either flat or negative GDP readings.

The level of economic activity is still more than 2 per cent below its pre-recession peak in real terms and the level of nominal GDP is almost 5 per cent lower, despite the nascent housing-led recovery.

The Canadian economy may be creating jobs now, but the level of employment is still 1½ per cent - about 260,000 jobs - shy of where we were at the October, 2008, peak. The employment-to-population ratio, at 61.5 per cent, is flirting with eight-year lows and is well below the pre-recession peak of 63.9 per cent.

This level of slack in the labour market is why wage growth has been sliced in half from 4.8 per cent a year ago to 2.4 per cent today.

The markets think the Bank of Canada will be increasing rates in coming months because the press statement has hinted at such for a year now. All we can say is this: The last time the Bank of Canada went ahead of the Fed, in 2002, all the rate hikes had to be reversed because as it turned out, the Fed's more tepid view of the world outlook at that time proved to be the correct one.

Remember, history doesn't repeat itself, but it often rhymes.

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and a guest columnist for Report on Business