INTEREST RATES: Bank of Canada hints at rate hikes on the horizon

The Bank of Canada took its first steps Tuesday toward returning the country to more normal interest-rate levels by signalling a more hawkish tone on inflation and acknowledging the economy is performing better than expected on “ vigorous” consumer demand.

The messages were conveyed in the bank’s latest interest-rate statement, which kept its record-low benchmark rate of 0.25 per cent and pledged to keep it there at least until July.

However, most bank watchers took note of subtle changes in the statement, compared with previous rate announcements, and there was enough there for them to begin the countdown to hikes.

“ I suspect [ Bank of Canada governor] Mark Carney and company are starting to feel the urge to tighten, not a strong urge now, but an urge nevertheless,” said BMO Capital Markets senior economist Michael Gregory

Among the key changes was a declaration from the bank that the risks to its inflation outlook are “ roughly balanced,” and no longer “ tilted slightly to the downside,” language that suggests deflation is no longer a concern and that price increases are creeping to a level that may prompt a response.

The bank sets its rates to achieve annual inflation of two per cent. The most recent data for January showed inflation at 1.9 per cent. Core inflation, which excludes volatile items such as energy, was two per cent. The bank had projected core inflation would not reach two per cent until the third quarter of next year.

The change may appear trivial, “ but it is nonetheless significant as it reflects an economic backdrop that continues to improve at a much faster pace than the bank envisaged,” said National Bank Financial senior economist Paul-Andre Pinsonnault.

The statement emerged a day after economic data indicated the economy grew at a robust five-per-cent annualized pace in the final three months of 2009, blowing past expectations for a four-per-cent gain and the central bank’s 3.3 per cent forecast.

Economists say the fourth-quarter performance has set the stage for another robust gain for the first three months of 2010. The central bank said economic activity has been “ slightly higher” than its projections, with the five-per-cent gain in the fourth quarter powered by “ vigorous domestic demand” and a recovery in exports.

The consensus remains the central bank will wait until July to begin raising rates. There are two more scheduled decisions between now and then, on April 20 and June 1.

How much and how rapidly the bank raises rates is open for debate, with economists estimating increases of one full percentage point to 1.5 points over the second half of 2010.

(prepared by Paul Vieira/Vancouver Sun)