Financial Update

· TSX + 111.82(Reuters) Monday as record oil prices bolstered resources and energy shares, offsetting a weak showing by financial services shares on persistent concerns about the credit crunch.
· Dow +35.25
· Dollar -.72c to $97.99US
· Oil + $.60 charged to a new high of $143.67 before settling lower at $142.61US per barrel
· Gold +$4.72US to $936.02US per ounce


Consumer expectations more dangerous than inflation
BARRIE MCKENNA Globe and Mail Update
Ben Bernanke is among a shrinking pool of people who still believe inflation is ebbing.

He and his colleagues on the U.S. Federal Reserve Board's interest-rate-setting open market committee said as much last week. As they left the central bank's key interest rate unchanged at 2 per cent – again – the committee said it “expects inflation to moderate later this year and next year.”
Really?

It's hard to see that scenario playing out. As the price of oil flirts with new highs above $143 (U.S.) a barrel and food prices continue to spike, consumers are braced for just about everything to cost more in the months ahead.

It's what economists call inflation expectations. And the anticipation of higher prices can be as dangerous as inflation itself. When people feel threatened by inflation, they react by demanding higher wages, which push up employer costs, perpetuating the problem.

In Europe, for example, one recent survey of European consumers cites a perceived rate of inflation at 12 per cent. The official inflation rate is in fact running at 3 per cent. There have been protests throughout Europe by fishermen and truckers about soaring fuel costs.

In the United States, the “expected” rate of inflation is running at more than 5 per cent in the year ahead – the highest rate since the 1980s, according to the University of Michigan's survey of consumer confidence. Actual inflation is at roughly 4 per cent.

Consumers may be overreacting to the price of items they purchase most often: groceries and gas. Mr. Bernanke apparently believes the spike in food and fuel prices is transitory and won't affect prices more broadly. He's betting workers and companies won't push wages and prices of other items higher, exacerbating inflation.

Food and fuel prices make up just a quarter of the consumer price index. So why worry?
Instead, the Fed is focused on the downside: the housing crunch, the credit crisis and a slowing economy. If there's inflation, it will be cured by slow growth, Mr. Bernanke has apparently concluded.

So, for now, he keeps the federal funds rate at a historically low level of just 2 per cent – half the rate of inflation.

There is another, more worrying scenario. Speaking in Basel, Switzerland, yesterday, a top official of the Bank for International Settlements urged central banks around the world to keep inflation expectations at bay. Malcolm Knight, the bank's general manager and a former deputy governor of the Bank of Canada, said it would be wrong to assume the recent spike in inflation is just a “blip” that will recede next year.

“We cannot be entirely confident about this reassuring assessment,” Mr. Knight told reporters. He warned of a “clear and present danger” of rising global inflation and inflationary expectations.
In its annual report, released yesterday, the BIS warned that inflation may be the trigger for a much more serious problem: a prolonged period of deflation. The central bank for central banks warned that rising food and fuel prices, coupled with high household debt levels, could send the global economy into a tailspin.

The bank ominously suggested the cooling economy could easily drown inflation, causing “much greater and longer-lasting” economic problems.

Kevin Hassett, an economist at the American Enterprise Institute and a key economic adviser to Republican presidential hopeful John McCain, is among those who worry the Fed has become too complacent about inflation. He frets about a reprise of the devastating double-digit inflation of the 1980s.

“The inflation outlook right now is as scary as it has been since Paul Volcker grabbed his lance and impaled the dragon in 1979,” Mr. Hassett wrote in a commentary posted on the institute's website.

Mr. Volcker was Fed chairman from 1979-1987. Inflation hit 14 per cent as he took the job, and his relentless effort to tame it over the next few years pushed the U.S., and much of the world, into a deep recession.

Let's hope Mr. Bernanke and his colleagues have not forgotten just how painfully high inflation can go – and what it takes to get it under control again.

Financial Update

TSX +111.15 kicking off the week by surging higher, buoyed by firm oil prices and a jump by BCE Inc after Canada's top court backed the buyout of the telecom company....

· Dow -.33

· Dollar -.11c to $98.44.

· Oil +1.38 to $136.74US per barrel

· Gold -$16.50US to $887.20US

Bond Rates: http://www.bankofcanada.ca/en/rates/bonds.html <http://www.bankofcanada.ca/en/rates/bonds.html>


Bank of Canada ceases $1B in liquidity injections

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Record staff and Record news services The Bank of Canada says it won't renew a $1 billion term liquidity injection to chartered banks once it has matured on Thursday, a further sign that the central bank believes the credit crisis is easing in Canada. The central bank cited "continuing improvement in market conditions since the end of April'' for the decision. "Indicative measures of bank funding costs remain well below those in a number of other major currencies,'' the bank said in a statement. The bank has been providing two streams of $2 billion in cash injections through 28-day purchase-and-resale agreements since December, but has of late begun to reduce the rollovers to $1 billion upon reaching maturity. Yesterday's announcement effectively removes one stream with the second maturing on July 10.

CIBC likely to take another big hit after downgrades

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David Friend The Canadian Press

Canadian Imperial Bank of Commerce is likely to endure another multi-billion charge that could dig more than $2 billion out of its flesh in the third quarter, some industry watchers are predicting. Estimates ranged from $1 billion to more than $2 billion yesterday as analysts weighed in on Moody's downgrading monoline insurer XL Capital Assurance to junk late last week."We expect CIBC will write off its remaining fair value exposure to XLCA in its third-quarter 2008 results,'' Blackmont Capital analyst Brad Smith wrote in a note, putting the total writedown at $1 billion.

Financial Update

Oil and financials could weigh on TSX this week as Fed mulls interest rates

· TSX -209.48 as financial issues were hurt by inflation fears and worries over more U.S. mortgage-related problems, while consumer stocks also fell.

· Dow -220.40

· Dollar -.17c to $98.33.

· Oil +2.69 to $134.62US per barrel

· Gold -$.50US to $903.70US

Bond Rates: http://www.bankofcanada.ca/en/rates/bonds.html <http://www.bankofcanada.ca/en/rates/bonds.html>

By Malcolm Morrison, The Canadian Press

TORONTO - Gains could be tough to find on the Toronto stock market this week as investors wonder how much further the oil sector can carry the TSX, while financial shares fight fresh headwinds.

Concerns around those two areas again stopped the Toronto market's main index from establishing itself above the 15,000 mark last week.

On Monday, traders will be looking for the market's reaction to the Supreme Court's decision to allow the takeover of BCE Inc. to go ahead and a statement by the banks financing the deal that they "expect that the transaction will close in accordance with the definitive agreement between BCE and the sponsors."

Shares of BCE have traded well below the $42.75 per share price offered by the group led by the Ontario Teachers' Pension Plan in recent weeks.

But investors will likely want to hold off on any big bets on the market ahead of the announcement on interest rates from the U.S. Federal Reserve on Wednesday.

"It's a Fed week," observed Michael Gregory, senior economist at BMO Capital Markets, adding that most analysts expect the U.S. central bank to leave its key interest rate unchanged at a four-year low of two per cent.

"I think they're very much on hold for awhile until they see how things pan out," Gregory said.

"I think they essentially indicated that (last) week with various Fed officials giving a sense that the market was getting way too ahead of itself in factoring in tightening."

But economists think there isn't much doubt that the Fed and other central banks will have to move rates upward sooner or later to prevent inflation from taking hold as near-record oil prices threaten to ripple through the economy.

"You talk about 2009, of course I think that's well within the cards," said Gregory.

Last week, the TSX composite index hit a record close of 15,073.13 before China moved to restrain fuel consumption by raising government-controlled prices and the energy sector stalled.

The index ended the week down 1.3 per cent, led by falling energy and financials.

The move by the Chinese government sent a chill through the Toronto market, where the oil sector has been largely responsible for the index's six per cent year-to-date gain.

The sector has surged 27 per cent so far this, but oil prices have been volatile.

"The fundamentals have put the market in such a position that even little things like (the Chinese announcement) cause huge price swings," said Gregory.

"We're at the point now where commodity price volatility has increased and will likely remain high going forward."

Meanwhile, the financial sector ended lower on a run of bad news at the end of the week.

This included a decision by Moody's Investors Service to downgrade the two biggest bond insurers, MBIA Inc. and Ambac Financial Group Inc., which underscored U.S. money-centre problems and heightened fears of bond-market instability.

And Citibank warned of more writedowns.

"I think there's more (bad news) out there somewhere," said Gregory, noting that investors remain cautious about banks and other financial service providers, especially in the United States.

"Yes these stocks are cheap but maybe there's a reason why they're cheap."