Bank of Canada stands apart as it raises rates

Posted on 22. Jul, 2010 by in News

Jeremy Torobin, Globe and Mail,  Published on Tuesday, Jul. 20, 2010 9:05AM EDT

A strong economy is allowing central bank take different actions than other G7 nations, but global weakening may upset the plan.

Mark Carney has now done twice what no other Group of Seven central banker appears even close to doing once – he raised interest rates for the second month in a row – but global developments could slow his hand.

Tuesday’s move, which brought the Bank of Canada’s benchmark overnight rate to a still-low 0.75 per cent, reflects Canada’s unique position as a rich country that has recovered almost all of the jobs lost during the recession, where a post-crisis housing boom has already come and gone, and where record overseas demand for safe government bonds is poised to allow Ottawa and the provinces fund a few more years of deficit spending without being crippled by interest payments.

But the Bank of Canada Governor’s window for taking back some of the super-low borrowing costs, both to ensure that inflationary pressures don’t build and to persuade consumers and businesses that they should start paying off debts now before rates go higher, may be closing sooner than expected.

Even as it raised its key rate by one-quarter of a percentage point, the central bank trimmed its forecast for Canada’s economic growth this year and next, as austerity measures in Europe and a fizzling rebound in the United States make for a slower global recovery and a “more gradual” bounce-back at home. Future moves will “be weighed carefully” against developments around the world, policy makers reiterated in the statement accompanying the rate hike, and, in turn, on what impact those may have on Canada’s exports.

The scaled-down forecasts tempered rate hike expectations, with most economists predicting one more increase Sept. 8, and possibly another Oct. 19, before what could be a long pause as policy makers wait for central banks in weaker economies like the U.S. and Europe to start tightening.

“Over all, they think they have a reasonable outlook ahead, but they’re clearly not so certain about it that they want to move quickly,” Avery Shenfeld, chief economist at CIBC World Markets in Toronto, said in an interview. “The bank’s forecast, while more moderate than the last one, is still reasonably solid. Perhaps too solid in light of the information coming in from abroad, but at this point the central bank isn’t quaking in its boots or it wouldn’t be raising rates.”

Canada’s economy will grow 3.5 per cent this year instead of the 3.7 per cent rate projected in April, and 2.9 per cent next year instead of 3.1 per cent, the central bank said in its revisions, which will be explained more on Thursday when policy makers release a comprehensive forecast. In 2012, the domestic economy will grow 2.2 per cent instead of the 1.9 per cent predicted in April.

The global recovery, the bank said, “is proceeding but is not yet self-sustaining,” and will be restrained as households, banks and governments in the so-called advanced economies work to get their finances under control.

Belt-tightening in Europe has reduced the risk of an “adverse outcome” to the continent’s debt crisis and raised prospects for “sustainable long-term growth,” but will slow the worldwide turnaround. Faith in Europe’s ability to contain the debt crisis that started in Greece and spread to countries such as Spain, Portugal and Ireland may be tested later this week, when EU regulators start releasing results from a series of “stress tests” on more than 90 of the continent’s banks.

As for the U.S., Canada’s main export market, the bank said private demand is “picking up but remains uneven.” Housing starts and consumer confidence in the U.S. have plunged amid persistently high unemployment and, last week, freshly released minutes from the Federal Reserve’s June meeting indicated there had been some discussion about whether the world’s biggest economy might need another emergency jolt.

“In the absence of job and credit growth, arguably two things Canada has a lot of these days, how can you sustain underlying demand in the U.S. beyond just the initial recovery phase of inventory restocking and a little bit of unleashing of pent-up demand?” Michael Gregory, a senior economist at BMO Nesbitt Burns in Toronto, said in an interview. “As we head into the autumn, the numbers are going to be a little more worrisome and weak for the U.S., and it’s going to raise that risk in the Bank of Canada’s mind.”

Even as analysts argue that Canada’s economy is sound enough to warrant one or two more rate hikes and, in some cases, worry that Mr. Carney could take too long to raise rates and thereby allow some price gains to accelerate, the central bank also attributed its revisions to “more modest consumption” in Canada, as the housing market cools and government stimulus spending fades.

In addition, investment by Canadian companies “appears to be held back by global uncertainties” and hasn’t rebounded from a sharp drop during the recession even as many firms are hiring, the central bank said.

Without being more specific, policy makers said that, over their projection period, they anticipate business investment and net exports will make a “relatively larger” contribution to growth. To date, it has been domestic consumption that has largely powered Canada’s economy out of the downturn.

Inflation, meanwhile, will stay near the central bank’s 2-per-cent target throughout the projection period, policy makers said, but the economy won’t return to full capacity until the end of 2011 – six months later than they had forecast in April.

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