Canada May Keep Rate at 1% as Global Risks Outweigh Inflation

Bank of Canada Governor Mark Carney
Bank of Canada Governor Mark Carney. Photographer: Joshua Roberts/Bloomberg

The Bank of Canada will probably keep its main interest rate unchanged for a seventh straight meeting today, as economic risks posed by indebted foreign governments outweigh concerns about quicker domestic inflation.

The Ottawa-based central bank will keep the target for overnight loans between commercial banks at 1 percent, where it’s been since September, said all 26 economists surveyed by Bloomberg News, in a decision due at 9 a.m. New York time.

Governor Mark Carney said last month the European debt crisis could drive up borrowing costs and slow the economic recovery. In the U.S., which buys three-quarters of Canada’s exports, lawmakers are trying to reach an agreement to raise the debt ceiling by Aug. 2 and avoid a default that Federal Reserve Chairman Ben S. Bernanke said would lead to a “huge financial calamity.” Canadian policy makers may still reiterate that interest rates will eventually rise after inflation reached the fastest since 2003 in May.

“They are blocked from responding to domestic issues because of these very deep and very real foreign concerns,” said Doug Porter, deputy chief economist with BMO Capital Markets in Toronto. “It’s almost an on-off switch: either things settle down and they get back at tightening quickly or it’s going to be a long time before we talk about tightening.”

The bank altered its wording at the last announcement May 31, saying its key rate would rise “eventually” as the economy recovers, changing language it had used since September. Investors will read today’s press release for further changes to that phrase, and will look for highlights of the bank’s quarterly economic forecast that will be published tomorrow.

‘Ready to Hike’

“It comes down to this mix, that Canada is looking relatively better, and the rest of the world is looking worse,” said Eric Lascelles, chief economist at Royal Bank of Canada Global Asset Management, which oversees about C$250 billion ($261 billion). “They need to be ready to hike if market and economic events justify it in September,” the next rate decision, he said.

Economists predict the bank will raise rates to 1.25 percent by the end of September and to 1.5 percent by year-end, according to a separate Bloomberg survey. By contrast, investors are betting on at most one quarter-point increase this year, with the six-month overnight index swap rate remaining at 1.05 percent yesterday. The swap rate represents what investors think the central bank policy rate will average over that period.

The Bank of Canada’s main policy goal is keeping inflation at 2 percent. The consumer price index accelerated to 3.7 percent in May from a year earlier, the fastest pace since March 2003. Carney said last month inflation will be above 3 percent “in the short term” because of high energy costs and the temporary effect of provincial tax increases.

Slowing Inflation

The central bank predicted in April that inflation will slow to 2 percent by mid-2012, which is also when policy makers said the economy would return to full output. Since then, Carney said economic growth in the second quarter may be slower than the 2 percent annual pace the bank estimated in April.

“I wouldn’t characterize the economy at this point as being overly robust,” BCE Inc. Chief Financial Officer Siim Vanaselja said at a June 9 investor presentation. BCE is Canada’s largest telephone company.

Automobile production was disrupted by Japan’s tsunami and earthquake, and Canada reported its fourth straight trade deficit on July 12. Other recent reports suggest the domestic economic recovery is progressing, including a jobless rate that fell to a 2-1/2 year low last month and a 21 percent rise in building permits in May.

“We expect to see continued gradual economic recovery as we’ve seen for much of the past year,” restaurant chain Tim Hortons Inc. Chief Financial Officer Cynthia Devine said on a June 7 conference call. “You also see the consumer under continued pressure.”

Even with slow economic growth, the policy interest rate can’t stay at 1 percent if the economy recovers next year, Lascelles said. “They are taking a bit of a gamble,” he said. “It is increasingly difficult to justify a policy rate as low as it is.”

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