Bank of Canada Governor Mark Carney may signal this week he’d rather raise interest rates gradually starting in June instead of waiting until July and moving in larger increments, economists said.
Carney may use the bank’s April 20 interest-rate statement, and a monetary policy report two days later, to give a rationale for rate increases beginning at the June 1 announcement date, said Paul-Andre Pinsonnault at National Bank Financial Inc. in Montreal. By moving sooner, the central bank can signal a slower pace of increases without sparking a large bond market reaction, he said.
With bigger rate increases later on, “you get the risk the economy will slow down a little more than you’d like,” Pinsonnault said. That risk would increase if global demand slows around the same time, he said.
Since April 2009, when the key rate was cut to 0.25 percent, the bank has said it would keep it at that level through the first half of this year, conditional on the inflation outlook. Carney shouldn’t be constrained by this commitment, said Sheryl King, head of Canadian economics and strategy at Merrill Lynch Canada.
“Canada has to move rates off of emergency-low levels,” Toronto-based King said, predicting an increase to 0.5 percent on June 1. “All along, the bank has warned investors the commitment to not touch rates was not a promise and earlier rate hikes were possible if conditions warranted.”
Investors have been increasing bets that the bank will start raising rates in June. The 3-month overnight index swap rate, which is based on what investors expect the policy rate will average over that period, reached 0.34 percent last week, the highest since just after the bank made its conditional commitment.
Elsewhere in credit markets, the central bank bought C$980 million ($968 million) of securities for one day in transactions aimed at keeping overnight trading near its target. Bank of Nova Scotia said it’s selling C$1 billion of bonds due April 2012.
A Bloomberg survey shows economists expect the 10-year government bond yield to increase to 4 percent by year-end from 3.68 percent. The 10-year yield would jump to greater than 6 percent if the bank waits and raises rates by half a percentage point at its July 20 meeting, because investors would bet on future moves being that size, King said. “That would probably short-circuit the recovery.”
Derek Holt, an economist in Toronto at Bank of Nova Scotia’s Scotia Capital unit, said the central bank needs to “temper” expectations about rate increases among market participants to avoid damping the recovery. On April 9 he advanced his prediction for a rate increase to June from July.
“We are entering into a period of time where growth will consistently overshoot consensus and Bank of Canada expectations,” Holt said. “They will shift toward a more hawkish bias in their forecast and tip the markets for a move in June.”
Core inflation will average at least 2 percent on a quarterly basis starting in the second half of this year, and the economy will grow 3.3 percent this year, Holt said.
Carney said March 24 that growth and core inflation have been higher than expected, and his plan to keep the rate unchanged through June was “expressly conditional” on the outlook for prices. The extra word “expressly” led investors to renew bets on rate increases.
Waiting another month also creates the risk that inflation expectations will advance further, Pinsonnault said. He cited the bank’s business outlook survey published April 12 that showed 40 percent of executives expect inflation to advance at a pace of 2 percent to 3 percent over the next two years, up from 20 percent in January.
Other economists said Carney will wait until July to raise rates because of his desire to keep the “conditional” pledge.
“The bank can wait one more month if it comes down to it in June to say that they met their conditional commitment,” said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce’s CIBC World Markets unit. Waiting until July would still allow for a “gradualist” increase in rates to 1.25 percent this year, he said.
The economy hasn’t made a full recovery and large interest rate increases could boost the country’s dollar faster than some exporters could handle, Toronto-based Shenfeld said. The currency reached parity with the U.S. dollar on April 6 for the first time since July 2008. Over the past year it has gained 19 percent against its U.S. counterpart.
No Need to Commit
The central bank can boost its economic forecast without committing to a June rate increase, said Jonathan Basile, a Credit Suisse Group AG economist in New York.
“I don’t know if they are going to go as far as dropping the conditional commitment, which would signal a June move,” Basile said.
Glenn Hanthorn, president of Mascot Truck Parts Ltd. in Mississauga, Ontario, is more concerned about when the U.S. economy recovers than Carney’s timetable. Mascot has been in business since 1936 and is starting to see a rebound in orders for pieces such as transmissions, he said.
“We have remained fairly strong in our business in Canada, but in the U.S., which is 60 percent of our business, it’s really hit us hard,” Hanthorn said. “If trucking is strong, the economy is strong.”