Published On Mon Jul 19 2010
Les Whittington
Ottawa Bureau OTTAWA-Forced into a high-risk balancing act by the sputtering world economy, the Bank of Canada is expected to continue with marginal increases in its trend-setting rate Tuesday. But the central bank will temper the decision with a strong note of caution.
Analysts expect Bank Governor Mark Carney to hike the key lending rate by 0.25 per cent to 0.75 per cent.
If so, it would be only the second increase since April 2009, when Carney dropped the overnight rate to a rock-bottom 0.25 per cent—and promised to keep it there for a year—to combat the recession.
He abandoned that strategy on June 1 when the rate was set at 0.50 per cent.
Higher Bank of Canada rates will result in increased borrowing costs for business, consumers and some homebuyers.
A gradual run-up in Canadian interest rates is warranted by the renewed strength of the Canadian economy in early 2010 and the need to head off any chance of runaway inflation as economic conditions brighten, economists say.
Having weathered the recession better than most industrialized countries, Canada has returned to a position of growth. While business conditions have weakened in the past few months, the economy experienced red-hot 6.1-per cent growth in the January-through-March period.
And the job situation is slowly improving. Most of the 300,000-plus jobs lost in the recession have been recouped even though a growing workforce has left unemployment at a still-high 7.9 per cent.
“Domestic conditions continue to argue powerfully for further rate increases,” TD Bank Financial Group said in an analysis of Carney’s options.
Under current conditions, the central bank is expected to gradually rachet up its key lending rate over the next six months to the 1.25-per cent range at the end 2010.
But Carney is likely to balance Tuesday’s decision with serious warnings about the uncertainties ahead, particularly the risky direction of the international economy and its potential impact on Canada.
The central bank has to walk a fine line, says TD Bank economist Eric Lascelles.
“It’s one of those very tricky situations where traditional economic analysis—and just looking at the forecasts—suggests ‘Yeah, sure, they should hike,’” he said. “Then suddenly you take into account all of these risks that are disproportionately skewed downwards and it’s a much tougher call.
“The strategy that the Bank of Canada probably employs is it sticks to the assumption that all is reasonably well as the forecasts suggest and continues to raise rates but stays on guard for surprises and keeps the market on guard for surprises.”
The major risks to the world economy are the shaky financial situation of European countries in the wake of the Greek debt crisis and the weak recovery in the U.S., which takes 75 per cent of Canada’s exports.
This picture is clouded by a less robust housing market in Canada, an impending decline in Ottawa’s stimulus spending and reluctance so far by Canadian companies to pick up the slack by increasing business investment.
“You can’t automatically assume that all will be well” with Canada’s economy, said Lascelles. “I think that growth is still the likely outcome but how strong will that growth be?”
United Steelworkers economist Erin Weir disagrees with the view that Carney should gradually tighten monetary policy.
He said inflation is still below the central bank’s 2-per cent target and, even if hiring is increasing, wages have been so flat that there is no threat of a wave of wage-driven price increases.
With the U.S. Federal Reserve Board keeping rates low to bolster the American business climate, higher rates in Canada could worsen the outlook. That’s because rising interest rates tend to increase demand for a currency as investors anticipate better returns, thus driving up the loonie on exchange markets. This in turn makes it harder for Canadian manufacturers to compete for sales south of the border.
“I don’t see any need to raise rates,” said Weir. “And I think the downside to raising them is that, especially in a context where the American Federal Reserve is holding steady, it will tend to push up the Canadian dollar, which is certainly a huge challenge for a lot of Canadian export industries that are struggling to try to recover.”
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