The Bank of Canada said today higher borrowing costs “may become appropriate,” leading investors to increase bets that policy makers will raise their benchmark rate from 1 percent later this year.
Economic growth and inflation will be faster than earlier forecast, the bank said today in a decision to keep its key rate unchanged for a 13th meeting. The announcement also said the economy will reach full output in the first half of next year, sooner than a January forecast for the third quarter of 2013, while Europe will emerge from recession later this year and the U.S. recovery will be stronger than expected.
“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,” policy makers led by Governor Mark Carney, 47, said in a statement from Ottawa today. “The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.”
The Bank of Canada may be poised to repeat its moves from 2010, when it led Group of Seven nations in raising rates as the economy emerged faster from a global recession. Trading based on overnight index swaps suggests a greater than 50 percent chance of an increase by October, and Canada’s dollar and bond yields jumped today.
Rates ‘Going Higher’
“This is a very firmly hawkish report,” said Ian Pollick, senior fixed-income strategist at RBC Capital Markets in Toronto. “Rates are going higher.”
The Canadian dollar extended gains after the decision, strengthening 1.2 percent to 98.74 Canadian cents per U.S. dollar at 12:15 a.m. in Toronto. One Canadian dollar buys $1.0128. Two-year government bond yields jumped 11 basis points to 1.34 percent. The yield reached as high 1.37 percent, the highest since August.
There is about a 55 percent chance of a rate increase by the Oct. 23 decision according to Bloomberg calculations based on overnight index swaps trading, versus a 45 percent chance of no move.
Economists at Bank of Montreal advanced their forecast for an increase to January 2013 from the third quarter of next year, the bank said in an e-mailed statement.
U.S. Federal Reserve policy makers say they plan to keep interest rates low “through late 2014” while the European Central Bank cut rates in December and the Bank of England this month maintained an asset-purchase program at 325 billion pounds ($518 billion).
Canada’s central bank today raised its growth estimate for this year to 2.4 percent from 2 percent, and lowered the 2013 forecast to 2.4 percent from 2.8 percent. It also gave its first prediction for 2014 growth, at 2.2 percent.
“We view this communique as an important and large step towards further normalizing the overnight rate,” said David Tulk, chief Canada macro strategist at Toronto-Dominion Bank (TD)’s TD Securities unit. An increase could come as early as September, he said in a note to clients, adding a move later in the year is more likely.
Inflation will be “somewhat firmer than anticipated in January,” the bank said today, citing “reduced slack and higher gasoline prices.” Consumer price gains will be “around 2 percent” through 2014 after moderating this quarter, the bank said.
Inflation, which was 2.6 percent in February, has exceeded the bank’s 2 percent goal for 15 straight months.
Reports this month have shown 82,300 new jobs were created and an annualized pace of housing starts of 215,600 units in March, both the fastest since 2008.
The recovery has been marked by stronger growth for companies linked to consumers and commodities, while factories continue to struggle.
Paper company Cascades Inc. (CAS) said April 12 it’s closing an unprofitable containerboard mill in Trenton, Ontario, with 130 workers. Vancouver-based Boston Pizza Royalties Income Fund raised its monthly distribution by 6.5 percent to 9.8 cents last month, citing “strong same store sales growth momentum.” It was the second increase in a year and the 15th since 2002.
Policy makers flagged that higher oil prices could slow economic momentum, noting that Canadian producers are receiving less for their output than the international price. In 2005, the central bank said higher oil prices tend to boost Canadian growth over time as higher investment outweighs the impact on consumers and other businesses.
The bank also reiterated today the Canadian dollar’s “persistent strength” is a drag on exports while high consumer debt burdens are “the biggest domestic risk.” Carney has warned consumers over the last year about record debt loads that may be unaffordable when borrowing costs climb.
“They know that if they raise rates too quickly domestic demand could struggle, and the housing market instead of having a soft landing could have a hard landing,” said Krishen Rangasamy, senior economist at National Bank Financial in Montreal. “We are still thinking that they are going to act in 2013.”
Today’s statement was the bank’s first since July that mentioned the possibility of higher borrowing costs. Last year, the bank said that “some of the considerable monetary policy stimulus currently in place will be withdrawn.” That language was removed in the September announcement.
Improving business and consumer confidence will help make private spending the main driver of economic growth as recent government budgets suggest public spending will contribute little to the expansion, the bank said today.
Finance Minister Jim Flaherty’s fiscal plan last month said Canada would eliminate its deficit by 2015 in part by firing government workers, while most provincial governments are also paring shortfalls.
“Economic momentum in Canada is slightly firmer than the Bank had expected in January,” the bank said in its statement. “The external headwinds facing Canada have abated somewhat, with the U.S. recovery more resilient and financial conditions more supportive than previously anticipated.”
To contact the reporter on this story: Greg Quinn in Ottawa at email@example.com