Are Canadian Rate Hikes Coming?

Includes: FXC
by: Market Blog

By David Berman

The Canadian dollar is certainly reacting in a big way to the Bank of Canada’s monetary policy statement, released on Tuesday morning: The loonie shot up by about 1.2 cents against the U.S. dollar, to $1.012 (U.S.). That marks its biggest one-day jump since November, and the value of the dollar is now closing in on its highest level since September, 2011.

No, the central bank didn’t raise its key rate, but rather held it at 1 per cent. However, it used unusually blunt language to suggest that the economic conditions pointed to a rate hike sooner than many observers had been expecting: “In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate....” To support this tougher view, the Bank of Canada even bumped up its economic growth forecast for 2012, to 2.4 per cent from 2 per cent previously.

But while the currency markets are taking the news seriously, economists seem to be divided over whether the bank is going to be able to carry through on the threat of a rate hike. Here are a few thoughts.

Avery Shenfeld, CIBC World Markets: “Will the rate hikes actually be forthcoming? We doubt it. Recall that in mid-2011, Governor Carney’s team was even more convinced that the need to tighten policy was at hand, and signaled as much by dropping the word “eventually” in describing its timing. But an economic bump in the road waylaid those plans, including a Q2 drop in Canadian GDP and the subsequent euro zone crisis. The Bank of Canada prudently opted to leave the existing stimulus in place while it waited for the clouds to lift.”

Doug Porter, BMO Nesbitt Burns: “The Bank is clearly uncomfortable with keeping interest rates below inflation when household debt continues to grind higher, and with the economy poised to reach capacity by early next year. At a minimum, the Bank will be raising rates before the economy reaches full potential (i.e. sometime in the first half of next year). We have pulled our first rate hike call forward to January of 2013, but if the global backdrop co-operates, the Bank will be moving much sooner than that given their revised outlook for inflation and the output gap.”

Paul-André Pinsonnault and Krishen Rangasamy, National Bank Financial: “After the presentation of the federal budget, it’s becoming apparent that fiscal drag isn’t likely to be as large as first feared, giving the BoC more room for rate action. Moreover, with the government deciding not to intervene with new rules to cool down the arguably overheating housing market, the onus is now on the BoC to address, on its own, the problem of household debt accumulation which it views as the ‘biggest domestic risk.’”