Bank of Canada Governor Mark Carney will offer a rationale today for why his next move may be a rate increase even as he reduces Canada’s growth forecast and investors bet on a cut.
Carney signaled the chance of tighter policy for a third straight time yesterday, while he kept his key lending rate at 1 percent and pared his 2012 and 2013 forecasts for Canadian growth. He will elaborate on that outlook in a Monetary Policy Report at 10:30 a.m., followed by a press conference at 11:15 a.m., in Ottawa.
Just talking about a rate increase sets Canada apart from central banks that are easing monetary policy, such as the U.S. Federal Reserve, the European Central Bank and the People’s Bank of China. Investors have priced in a 25 percent change that Carney will cut rates by the end of the year as the world’s 10th largest economy is hampered by Europe’s fiscal crisis and a slow U.S. recovery, according to trading in overnight index swaps.
“This is the story of the Bank of Canada over the last few years,” said Thanos Bardas, a managing director in Chicago at Neuberger Berman LLC, which oversees about $89 billion in fixed-income assets. “Every time they would like to raise rates because they think the economy is nearing full potential there are external events that get in the way.”
The central bank trimmed its economic growth forecasts to 2.1 percent this year from 2.4 percent, and to 2.3 percent in 2013 from 2.4 percent. It also said the U.S. recovery is slowing while Europe’s economy may contract again. Today’s report will give new quarterly projections for economic growth and inflation and details on the bank’s view that consumption and investment will lead Canada’s expansion.
Avery Shenfeld, chief economist at CIBC World Markets in Toronto, said he wants to see more on the central bank’s global and U.S. forecasts today.
“They understand there is big cloud of uncertainty on any forecast for 2013,” Shenfeld said.
Canada’s benchmark 10-year bond yield dropped to a record low Monday on demand for the safest assets, amid speculation the U.S. economy is slowing. Yesterday the 2.75 percent security maturing in June 2022 fell 23 cents to C$110.08, with the yield rising 2 basis points to 1.64 percent.
The Canadian dollar appreciated against its U.S. counterpart yesterday after the bank reiterated interest-rate increases remain possible, while Canadian stocks gained for a third day.
The Bank of Canada is “not seeing nearly enough of a threat to growth to even think about the prospect of cutting rates any time soon,” Shenfeld said.
Carney probably needs to see signs of further economic weakness from Europe or Canada before he would consider abandoning the plan to raise rates, said Sal Guatieri, senior economist at BMO Capital Markets in Toronto.
Another trigger would be a large shift in Canada’s inflation outlook, Guatieri said. He pointed to the central bank stable forecast for core inflation, which is used as a guide to future trends.
While economists say rate reductions are unlikely, investors are equally skeptical Carney will follow through with higher rates this year. With Europe’s turmoil continuing and Fed Chairman Ben S. Bernanke projecting slow progress in reducing U.S. unemployment, swaps trading shows no chance of a Bank of Canada increase by the end of the year.
However Carney’s statements are interpreted by investors, the central bank’s hands aren’t tied, said Derek Burleton, deputy chief economist at Toronto-Dominion Bank in Toronto.
“The bank’s entitled to change its view if things change dramatically,” he said by telephone, adding a policy rate at “one percent is still an emergency rate.”