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There have been a number of significant economic and financial developments since the time of the July Monetary Policy Report Update.

Barker examines changes in the foreign exchange market, which is in a period of transition. Since the mid-1990s, three closely inter-related and mutually reinforcing factors–electronic trading platforms, a changing mix of market participants, and computer-driven algorithmic trading strategies–have been accelerating market growth and are creating a profound structural transformation. As the balance of market participation shifts between bank and non-bank accounts, large and small participants, and domestic and global players, the market is adopting some of the characteristics of an "exchange" model and is arguably becoming more liquid and operationally efficient.

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Siamese Gaming Tokens

The tokens pictured here are part of the National Currency Collection, Bank of Canada.
Photography by Gord Carter, Ottawa.

The dramatic growth in China's exports of consumer goods such as clothing, toys, and electronics, and imports of primary commodities such as oil and metals is having major effects on global supply and demand. In examining China's role in global relative price changes, Francis finds that downward pressure on the relative prices of consumer goods is likely to persist as China's large labour supply continues its migration into manufacturing. Likewise, China's size and growth will also remain key drivers of global commodities demand for some time. Despite these forces, inflation-targeting central banks have the tools to keep inflation close to target, thus offsetting any persistent upward or downward inflationary pressure.

Financing costs are important for both firms and the economy, affecting investment decisions and, ultimately, economic growth. Despite concern among policy-makers that the cost of equity financing may be higher in Canada than in the United States, empirical evidence supporting this view is mixed. Yet Canadian firms may not undertake as many projects that could potentially enhance growth if the cost of equity financing in Canada is relatively high. The article summarizes research by Jonathan Witmer and Lorie Zorn on the influences on the cost of equity in Canada and the United States, using an updated methodology that controls for firm characteristics and aggregate-level factors. In their sample, the cost of equity was 30–50 basis points higher in Canada over 1988 to 2006 but appears to have dropped in the post-1997 period. The results have policy implications related to such factors as firm size, disclosure, and securities regulation and enforcement.

At this 2006 workshop hosted by the Bank of Canada, an international group of market participants, regulators, and policy-makers gathered to assess recent developments in the derivatives market. Among the topics discussed were the recent prodigious growth in risk-transfer instruments, including credit derivatives and inflation-linked derivatives, as well as the accompanying challenges and benefits. Overall, the development of derivatives markets was seen as providing broad economic benefits, including more complete financial markets, improved market liquidity, and increased capacity of the financial system to effectively price and bear risk. Yet concern was also voiced that market participants do not fully understand the risks that arise in trading credit derivatives.

For many years, the Bank of Canada successfully responded to occasional eruptions in counterfeiting by improving the security features on bank notes. The surge in counterfeiting that occurred while the Bank prepared to launch the Canadian Journey series, however, reflected increasingly rapid advances in computer technology that were changing the counterfeiting environment. The article describes these and other challenges that affected the new series and describes how the Bank developed a comprehensive new approach to its currency program and incorporated the valuable lessons it learned from these challenges. Designed to combat counterfeiting and meet the needs of the public, the new strategy includes increased research and development on new bank note security features, an intensified focus on retailer and public education, and a focus on law enforcement.

Overall, businesses continue to be positive about the economic outlook, notwithstanding lower expectations for U.S. economic growth and recent financial market turbulence.

Economic growth and inflation in Canada in the first half of this year have been stronger than expected in the April Monetary Policy Report.

Expectations regarding future sales growth are essentially unchanged from the last survey. Investment and employment intentions have declined from the very high levels reported in the previous survey, but continue to be solid.