Interest rates expected to edge up

Bank of Canada announcement at 9 a.m. ET

Last Updated: Monday, July 19, 2010 2:23 PM ET
CBC News

The Bank of Canada, weighing strong domestic growth against weakness internationally, will likely raise its key lending rate by another quarter of a percentage point Tuesday morning, economists say.

That would bring the central bank's overnight lending rate to 0.75 per cent.Bank of Canada governor Mark Carney is shown during a panel discussion last month at the International Economic Forum of the Americas in Montreal. (Graham Hughes/Canadian Press)
Increases in the overnight lending rate generally lead directly to increases in lines of credit rates, variable-rate mortgages and other demand loans.

All 12 primary securities dealers expect the central bank to announce a quarter percentage point hike. A survey of 20 economists by Bloomberg found similar unanimity.

If that rate hike does materialize, it would be the second straight hike by the bank, which had left its benchmark lending rate at a rock-bottom 0.25 per cent for more than a year to provide a shot in the arm to a struggling economy.

Canada's central bank was the first in the G7 group of industrialized economies to raise interest rates since the global financial crisis began unfolding.

Canada's economy faring better than most
Recent data has shown the Canadian economy continuing to shake off the effects of the recent slowdown.

The most recent employment report issued showed that Canada created 93,200 jobs in June, far above economists' forecasts. The Canadian economy has now recouped almost all of the jobs lost in the recession.

The unemployment rate fell to 7.9 per cent — its lowest level in more than a year.

Bank of Canada surveys released last week suggest that Canadian businesses remain optimistic as far as sales and hiring are concerned.

"With solid employment growth powering consumers, and business investment now surging, Canada's domestic economy still looks solid," noted Bank of Montreal economist Benjamin Reitzes.

The international economic recovery has been more uncertain. Recent U.S. and European economic data, for instance, has been tentative at best.

Analysts say that weakness should be enough to keep the Bank of Canada from aggressively raising rates.

TD Bank economist Grant Bishop agrees that the central bank will hike by a quarter point Tuesday, but thinks the bank will underscore "the economic uncertainties in its communiqué, leaving an open door to a pause on rate hikes if conditions warrant."

A survey of 20 economists by Reuters finds that most expect the central bank's key lending rate will be at 1.25 per cent the end of the year, meaning that a couple of additional small rate hikes may be in the offing after Tuesday's, along with a pause or two.

Some experts see peril in call for higher interest rates

The Canadian Press

Date: Mon. Jul. 19 2010 8:09 PM ET

OTTAWA — Bank of Canada governor Mark Carney has seldom heard such unanimity about what he should do with interest rates at a time of economic uncertainty.

The consensus of 12 economists surveyed is that the governor will hike the policy rate by a quarter point for the second time in as many months Tuesday to 0.75 per cent, still an extremely low level.

It's the same verdict for the 11 private sector and academic analysts who made up the C.D. Howe Institute's monetary policy council this month -- all casting their vote for further rate increases. Four even called for a half-point jump to one per cent.

As well, the markets have priced in a quarter-point hike for weeks.

But a few bearish economists are urging Carney to ignore the dubious wisdom of crowds, warning of potential danger if he succumbs to the pressure to raise borrowing costs as the economy is starting to recover from recession.

"I don't believe the case for hiking rates is valid, and I think Canada will pay for this," says Carl Weinberg, chief economist with U.S.-based High Frequency Economics.

Higher interest rates drive the cost of borrowing higher, discouraging consumer spending and business investment that are key to economic growth. As well, Canada will open up a three-quarter point interest rate differential with the U.S., which will raise the value of the loonie and squeeze Canadian exports to the United States.

"You could push the economy back down into the hole again," Weinberg warns.

Brian Bethune of IHS Global Insight concurs, saying Carney's first mistake was to signal a leaning towards higher rates in April, then following through with the first rate hike in three years on June 1.

The result was that markets pushed up mortgage rates in the spring by a full point percentage point, helping to kill off the housing rally, which had been a key driver of Canadian growth.

Carney himself appeared to express some reticence last month, noting that the global recovery was uneven and in advanced economies, "heavily dependent" on government and central bank stimulus. He wrapped up by cautioning against counting on a second hike on July 20, as many had and still do.

"Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments," he advised.

Since, almost all indicators have gone south. Along with the European debt worries is concern that the U.S. may be heading toward a double-dip recession. China has advised its growth will be more moderate going forward.

In Canada, the economy followed an extraordinary 6.1 per cent acceleration in the first quarter with a sudden thud in April -- no growth. Retail sales, housing, manufacturing and balance of trade have all turned negative.

The argument for further interest rate hikes, as expressed by the C.D. Howe panel, was that the need for so-called emergency-level rates had ceased and that financial-market indicators point to inflation above two per cent -- the central bank's target -- in the next few years.

Royal Bank chief economist Craig Wright, who is a member of the panel, said the bears are exaggerating the impact of modest rate increases from what are unsustainably low rates.

He points out that Canada had the best two months of job creation on record in April and June, when employment grew by 109,000 and 93,000 respectively.

"The crisis has eased, and in that environment the crisis setting for both interest rates and fiscal policy can be eased as well," he argued. "The Bank of Canada is not looking at inflation today, it's trying to extrapolate where it will be in 12 to 18 months and if we don't moderate growth, we will run into inflationary concerns."

Wright does agree with the bears that this is no time to be aggressively tightening policy.

But labour economist Erin Weir of the United Steelworkers says any increase, even a small one, is without basis.

While 372,000 new jobs were created during the past year as of June, 270,000 more people joined the labour force during that period, he notes. This explains why the unemployment rate remains relatively high at 7.9 per cent, two points higher than it was before the recession.

And Bethune calls inflation a bogeyman. It is currently a tame 1.4 per cent, and with the global economy braking, unlikely to rear its head any time soon.

Bethune suggests an almost psychological fear of low rates may be behind the push to raise them. He reflects back to the summer of 2008, a few months before the economy caved in, when the consensus was near unanimous that rates were still too low. The concern looks absurd now.

"They are discomfited, they get twitchy, their feet are jumping because rates are too low," he says of monetary economists.

"Even in the Fed (U.S.'s central bank), there was an emerging consensus early in 2010 that it would have to have an exit strategy and start implementing it within months ... and now look where we are." Last week, the Fed was considering further stimulus as it downgraded American's economic outlook.

Bethune says Carney should look past the temporary strong jobs numbers and already past first quarter growth, and instead focus on the weak U.S. recovery and the drag it is bound to have on Canada going forward.

"It would be hard for them (Bank of Canada) not to raise rates when there are so many people saying raise rates, but this is when the central bankers earn their money," he said.

Mark Carney’s balancing act: Need for higher rates vs. global risk

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.”

What to expect from Bank of Canada

Paul Vieira, Financial Post · Monday, Jul. 19, 2010

OTTAWA -- Bank of Canada governor Mark Carney returns to the spotlight this week as he unveils the central bank’s latest interest-rate decision -- another increase is expected -- and economic outlook. He’ll also appear before Ottawa journalists Thursday to offer his view in his own words on the outlook on the economy, and whether it is headed for a dreaded double-dip as some have feared. Here’s a rundown of the key things to watch for this week from the Bank of Canada.

What is likely to happen to rates?

The Bank of Canada is widely expected Tuesday to raise its benchmark interest rate by 25 basis points, to 0.75%, as Canadian economic data -- especially on the jobs front -- remain relatively robust. Core inflation, which removes volatile items, remains close to the central bank’s 2% target. And indications are Canada’s economic growth, the best by far among Group of Seven countries, is beginning to chip away at the spare capacity the recession created. In all, analysts argue there is no need for the central bank to keep its key policy rate at emergency-like levels.

There are those, led by academics who sit on the C.D. Howe Institute’s monetary policy council, who suggest a 50-basis-point hike is required in an effort to get the policy rate back to a sustainable level before inflationary pressure builds. Meanwhile, analysts such as Brian Bethune of IHS Global Insight believe the Bank of Canada should hold off on rate hikes due to the increased risk of a “synchronized slowdown” among industrialized economies -- notably the United States and Europe.

What the Bank of Canada statement is likely to say?

Expect the central bank statement to mimic the pattern followed when it last raised rates on June 1 -- namely, hawkish action followed by dovish language. This gives Mark Carney, the Bank of Canada, enough flexibility to keep markets guessing, plus allow him to shift gears on a moment’s notice should the global economy deteriorate.

“This hawkish action/dovish language tag-teaming will keep markets on their heels, with the effect that although the market will usually gravitate towards the belief that the next decision will be a hike, it will remain slightly queasy about this assumption, and distinctly uncomfortable about later prospects,” said Eric Lascelles, chief Canadian strategist at TD Securities.

Further, this statement will provide a sneak peak of the Bank of Canada’s latest economic outlook, to be published Thursday. It is possible the central bank scales back its growth forecasts for the Canadian economy, given the set of weak data emerging from the United States and elsewhere. Previously, the central bank expected 3.7% expansion this year and 3.1% in 2011. There should be little mention of the Canadian dollar, as it has traded at roughly the mid-US90¢ range over the past two months.

What about interest rates for the rest of 2010 and 12 months out?

This is where opinions differ sharply, and that is best illustrated in the latest recommendations from the C.D. Howe Institute’s monetary policy committee -- which sort of acts like a shadow central bank. Council members believe a series of overnight rate increases over the coming year are necessary, as the output gap narrows and an emergency approach become less appropriate. However, the pace at which rates increase is up for debate.

Some Bay Street economists on the council lean toward just two more rate hikes, at 25-basis-point apiece, for the remainder of 2010. One of those analysts, Avery Shenfeld of CIBC World Markets, said the central bank would hike its benchmark rate to 1.25% before it pauses for “at least” two quarters, as relatively low borrowing costs will be required as the global economy grapples with widespread budget cutting and weakening consumer demand.

Meanwhile, most of the academics on the C.D. Howe council envisage the central bank’s rate hitting 2% and above by the end of 2010, and as high as 3.75% in one-year’s time. These academics argue that current rapid growth in money supply and higher-than-expected inflation will force the central bank’s hand.

pvieira@nationalpost.com