By Eric Beauchesne
The Ottawa Citizen
Wednesday, July 25, 2007

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OTTAWA -- News of a stunning surge in spending by Canadian consumers sent the loonie soaring more than a cent to a new three-decade high of more than 96.5 cents US and set the stage for more interest rate increases.

Adrian Mastracci, fee-only portfolio manager at KCM Wealth Management in Vancouver, says, "Days like this are a normal part of investing, so, overreacting should be avoided."

The near three-per-cent jump in retail sales in May, reported by Statistics Canada on Tuesday, was almost six times the 0.5-per-cent expected, and the steepest monthly gain in a decade.

"While a good month was anticipated, this was a blowout," said CIBC World Markets economist Avery Shenfeld.

"Retail sales ... blew well past even the most optimistic forecasts," added TD Securities economist Jacqui Douglas.

The good news on the economy, however, was not only bad news for manufacturers who have been hammered by the high dollar, but also for borrowers as the evidence of surprising economic strength added to expectations of further interest rates increases.

"This clearly puts additional Bank of Canada tightening in play, above and beyond a second quarter-point rate hike in September," said BMO Capital Markets economist Douglas Porter.

The loonie hit a high of 96.70 cents US before easing back to close at 96.36 cents US, up from 95.41 cents US Monday.

The loonie's strength also reflected a further slump in the U.S. greenback on news of spreading losses from sub-prime mortgage defaults in that country's depressed housing market.

The U.S. dollar fell to what was a record against the euro and a quarter-century low against the British pound.

The spectre of higher interest rates was also blamed in part, along with a retreat in high energy prices and some profit-taking by investors, for a 400-point plunge in Bay Street's benchmark S&P/TSX index.

"It looks ugly ... but let's not forget that we've had a bull market, virtually and literally since October 2002," noted Adrian Mastracci, portfolio manager with Vancouver-based KCM Wealth Management Inc., suggesting investors not panic to what could be a short roller-coaster ride. "Days like this are a normal part of investing, so, over reacting should be avoided."

The Bank of Canada earlier this month raised its trend-setting rate for the first time in more than a year to a six-year high of 4.5 per cent to cool the economy and inflation, which is running above its two-per-cent target.

At the time it warned that a further "modest" increase in rates may be needed, which most analysts interpreted as a single-quarter point hike next month.

Merchants' sales rose 2.8 per cent in May to $35 billion, the fourth-straight monthly gain.

The increase was also widespread with only furniture, home furnishings and electronics stores suffering declines and that followed six straight months of gains.

Even after discounting for price increases, sales volumes were still up a sharp 2.5 per cent, the strongest growth in over five years.

Quebecers led the spending spree, with a 4.9-per-cent jump in sales as public servants went out and spent some of the province's public service pay-equity settlement that boosted incomes.

But even without Quebec, the 2.8-per-cent increase in sales in the other provinces and territories, all of which also posted greater-than-expected gains, was way beyond expectations.

Record-high employment and a modern-day record-low unemployment rate were credited with underpinning the overall strength in consumer spending.

"This is a trans-Canada phenomenon," said Peter Woolford, of the Retail Council of Canada.

The strength in spending by consumers is being driven by strong job growth, rising incomes, and what are still relatively low and stable interest rates, all of which have bolstered their confidence, he said.

While such steep monthly increases in spending will not continue, Woolford said the industry expects strong sales growth through the rest of the year at least.

A reflection of the strong job growth was another report showing that the number of unemployed drawing EI benefits in May was 470,520, down 1.3 per cent from April and 4.2 per cent from a year earlier.

"Consumers are apparently in a very confident mood, as indicated by strong new car sales over the last three months," observed National Bank of Canada economist Marc Pinsonneault.

"On a regional basis, resources-rich provinces still dominate retail sales growth so far this year, being the only ones with growth significantly above the national average," he noted "At the opposite, Ontario is second last, suggesting that dismal job creation is taking its toll on consumption."

NOTE: The information provided above is intended for general informational purposes only. It does not constitute advice for anyone's specific situation. Everyone should always first consult directly with their advisors to determine the appropriateness of any information contained above before taking any action. KCM Wealth Management Inc. assumes no responsibility for any loss or damage arising from the use of, or reliance upon the above information.