Canada: A Chill from Inflation Jitters

Spurred on by data showing a strong recovery, the Bank of Canada became the first central bank of the major industrialized nations to hike interest rates.

On Apr. 16, the BOC hiked its overnight funding rate by a quarter-point, to 2.25%. The announcement said that "a robust recovery appears to be under way in Canada." The latest data bear that out: Retail sales jumped 1.1% in January and fell back only 0.1% in February. Housing starts in the first quarter were at their highest level in 12 years. And factory shipments rose in January and February, the first back-to-back gains in two years.

The strength suggests that Canada's real gross domestic product grew at an annual rate of about 4% in the first quarter. In its April Monetary Report, the BOC projected the economy will grow between 3.5% and 4.5% in the first half of 2002. That's up from a forecast of only 1% to 2% reported in January.

The report also said growth over the next two years should be robust enough that "the economy could be operating at full capacity in the second half of 2003." Consequently, the BOC is worried about future inflation. Total consumer prices rose 1.8% in the year ended in March, and the core rate (which excludes eight volatile items) stood at 2.1%, just above the BOC's uppermost target of 2% for that inflation rate. Indeed, in its Apr. 16 rate-hike statement, the bank made it clear that it was not tightening policy, but only reducing the amount of monetary stimulus to keep inflation at its 2% target. And the Monetary Report strongly suggested that the central bank will continue to raise rates, probably in small quarter-point intervals.

After the rate hike, the bank said "substantial monetary stimulus remains in place." The observation may quell critics who worry that the Canadian economy does not have enough momentum to carry itself through the year. But with its forecast of solid GDP growth for 2002, the BOC clearly thinks its main worry now is not growth prospects, but stopping any inflation pickup in 2003.

By James C. Cooper & Kathleen Madigan

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