INTEREST RATES: Bank of Canada tips its hand on rates

The Bank of Canada may have let the cat out of bag on interest rates Thursday, analysts say, when it indicated that “gradual” hikes are forecast to keep inflation near its preferred 2% target.

The suggestion, described as a “candid moment” by one analyst, was contained in the central bank’s latest economic forecast, which indicated economic growth petered out sharply last quarter and a slower pace of expansion is set to continue through next year.

In discussing its projection on consumer prices — in which core inflation is expected to be near 2% from now until the end of 2012 — the central bank said the forecast “includes a gradual reduction in monetary stimulus consistent with achieving the inflation target.”

The governor, Mark Carney, told reporters in Ottawa this shouldn’t be construed as a clue to future rate decisions. “Risks around the projection are elevated and there is no preordained path for interest rates in this country,” he said.

Some economists had a different view.

“In the context of ‘nothing is preordained,’ to me this is sort of an add-on — nothing is preordained except the path is toward higher interest rates,” said Craig Wright, chief economist at Royal Bank of Canada. “Just how quickly and how high are up for discussion.”

In raising its key policy rate this week to 0.75%, the central bank said “considerable uncertainty” in the global economic outlook would force the bank to “carefully” weigh future rate decisions. Plus, the statement’s cautious tone led markets to temper expectations for further rate hikes this year.

“While the Bank is being purposely ambiguous about near-term policy prospects, the longer-term prospects are unambiguous,” Michael Gregory, senior economist at BMO Capital Markets, said following the release of the central bank’s outlook. “The Bank of Canada has a bias to tighten.”


Mr. Gregory added reference to “gradual” removal of stimulus was not in the last economic outlook, which leads him to believe the central bank wanted to “properly anchor” expectations among Canadians for higher rates — especially those with higher debt-to-income ratios.

Uncertainty about further rate hikes this year crept in after the central bank revealed the output gap, or the amount of slack in the economy, would not close until the end of the year, or six months later than expected. Markets had priced in just a 50-50 chance of a rate hike at the next meeting of the governing council on Sept. 8, but that has since risen to a two-thirds probability as of yesterday.

The outlook expanded on the scaled-back growth forecast the central bank now envisages. After posting annualized growth of 4.9% in the final quarter of last year and 6.1% in 2010’s first quarter, the central bank forecast GDP to expand just 3% for the three-month period ended June 30 — down from its original call of 3.8%. Quarterly growth maintains that 3% annualized pace in the second half of the year, versus the originally expected 3.5% expansion.

All told, growth expands 3.5% this year and 2.9% in 2010, down from previous expectations, due to a renewed focus on budget cutting in advanced economies. Despite the downgrade, Mr. Carney said the odds of a double-dip recession — as some watchers have warned — are “very low.”

And while the outlook, much like the rate statement, expressed caution over the direction of the economy, it also suggested upside surprises could be in store. Household spending could exceed expectations, it said, should confidence remain robust and credit conditions continue to be “favourable.” And business investment in machinery and equipment is expected to weigh in as a major contributor to Canadian growth as companies take advantage of credit conditions and large cash positions. Recent data suggest this trend is underway.

(prepared by Paul Veira/Financial Post/Vancouver Province)