Bank of Canada Raises Key Interest Rate, Says U.S. Weakness Trims Outlook
The Bank of Canada raised its benchmark interest rate today for a third time this year, and said it expects households and businesses to spend even as the outlook for the U.S. economy weakens.
The bank raised its target rate for overnight loans between commercial banks to 1 percent from 0.75 percent, matching estimates from 14 of 20 economists surveyed by Bloomberg. While the country’s recovery will be “slightly” slower than it had projected because of a weaker outlook for the U.S. economy, inflation is in line with expectations, it said.
“Consumption growth is expected to remain solid and business investment to rise strongly,” the Bank of Canada said in a statement. “Both are being supported by accommodative credit conditions, which have eased in recent weeks mainly owing to sharp declines in global bond yields.”
The Canadian dollar gained on the comments and investors increased bets the central bank will continue raising interest rates to remove stimulus. The yield on December 2010 bankers’ acceptances contract, the most actively traded contract, jumped to 1.30 percent, its highest in a month. The contracts have settled an average of about 20 basis points above the central bank’s overnight target since 1992, Bloomberg data show.
‘Not Fazed’
“The overall impression I’m left with is they’re a little bit hawkish or bent on further rate hikes than I had been expecting,” said Doug Porter, deputy chief economist with Bank of Montreal’s BMO Capital Markets unit in Toronto. “The fact is that they’re just not fazed by the slowdown we’ve seen in the U.S. or Canada.”
Porter said he may reconsider his call that the central bank will pause on rate increases for the rest of the year.
The Canadian currency appreciated 1.1 percent to C$1.0367 per U.S. dollar at 10:32 a.m. in Toronto, from C$1.0480 yesterday.
Canada’s central bank targets a 2 percent inflation rate. The Bank of Canada projected in July that overall and core inflation will advance at about that pace through 2012 as the economy returns to full capacity after last year’s recession. The forecast anticipates a “gradual” rise in interest rates to keep inflation at that pace, the central bank said at the time.
Inflation dynamics in Canada are “essentially unchanged,” the Bank of Canada said today.
‘Exceptionally Stimulative’
“It doesn’t sound like a bank that’s prepared to move to the sidelines anytime soon,” Porter said.
Canada’s three interest rate increases since June are the first among Group of Seven countries after last year’s global recession. The country has recovered from the slump faster than the U.S., having already returned to pre-recession levels of employment. The bank today said that while financial conditions in Canada have “tightened modestly” because of the increases, monetary policy remains “exceptionally stimulative.”
“This is consistent with achieving the 2 percent inflation target in an environment of significant excess supply in Canada,” the Bank of Canada said.
The Canadian economy, after growing at an annualized 5.8 percent pace in the first quarter, slowed in the April-June period to a 2 percent rate -- a full percentage point below the bank’s July prediction. The report, though, also showed domestic demand remains buoyant, led by investments from businesses such as Potash Corp. of Saskatchewan Inc. and Suncor Energy Inc. Business investment in plant and equipment expanded 3.5 percent in the second quarter, the largest quarterly gain since 2005.
U.S. Weakness
Further increases would need to be “carefully considered” given uncertainty around the outlook, the central bank said today. The U.S. rebound is being restrained by high joblessness, the bank said, adding “recent indicators suggest a more muted recovery in the near term” for the world’s largest economy.
“The bank now expects the economic recovery in Canada to be slightly more gradual than it had projected” in July, policy makers said. “Any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook.”
Policy makers, who next meet Oct. 19, may still want to wait to tighten policy further in coming months amid a dampening outlook for the U.S. economy, said Benoit Durocher, an economist with Mouvement Desjardins, Quebec’s largest credit union, in Montreal.
“Because of the recent economic data in the U.S. and Canada, the bank will significantly revise its outlook downward in October, and that will open the door for a pause,” Durocher said.
Last month, diminishing prospects for U.S. growth sent global stocks tumbling and prompted the Federal Reserve to signal the possibility of further monetary measures.
Still, “if we get positive surprises in the next few weeks, the bank may well keep raising rates,” Durocher said. “Nothing can be excluded for October, because the bank didn’t close any door.”
To contact the reporters on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net; Alexandre Deslongchamps in Ottawa at adeslongcham@bloomberg.net.
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