Interest rates climb, more rises foreseen
The Bank of Canada hiked interest rates by a further quarter point and made it clear it’s far from finished. The central bank increased its overnight rate to 3 per cent — as widely expected — but the aggressive tone of the accompanying statement packed enough surprises to convince Bay Street that the trend- setting rate could hit 4 per cent or higher next year. Bank governor David Dodge had been preparing the public for a series of rate increases to bring the overnight lending rate closer to a neutral level — the point at which it neither stimulates nor dampens the economy. Perhaps his clearest signal came in a visit last month to Toronto when he revealed he expects high energy prices to keep inflation “ well above” 3 per cent for the next few months, too high for the central banker’s comfort.
Yet, many forecasters refused to believe Dodge would raise the overnight rate past 3.5 per cent by next year.
Yesterday’s statement won over the skeptics.
“Their hawkish commentary along with relatively strident remarks from almost every other central bank in the world, suggest there is a very clear program in place,” said Doug Porter, deputy chief economist at BMO Nesbitt Burns.
Porter now expects the overnight rate will hit 4 per cent by
early next year, up from his prior forecast of 3.5 per cent.
“ I wouldn’t go beyond that yet, though,” he added.
“ Consumers who already have record debt levels, faced with mounting energy bills and now higher interest rates may pull in their horns. That would be the one concern I have.” The central bank said the global economy continues to grow at a solid pace and that higher energy prices are stoking inflation.
“ Given that the Canadian economy now appears to be operating at capacity, some further reduction of monetary stimulus will be required to maintain a balance between aggregate supply and demand over the next four to six quarters, and to keep inflation on target,” the statement read.
Canada’s chartered banks responded by raising their variablerate mortgages and their prime lending rates by a quarter of a percentage point. Some, including the Royal Bank of Canada, increased their fixed- rate mortgages by 0.10 to 0.15 of a percentage point. The Bank of Montreal, which has one of the most agressive interest- rate forecasts, is predicting the overnight rate will reach 4.5 per cent by next fall.
“ The Bank of Canada is certainly worried more about higher inflation than weaker growth because the economy is already operating at capacity,” said Sal Guatieri, senior economist at the Bank of Montreal. He thinks inflation fears will prompt investors to drive up 10year government bond yields, which directly influence longerterm mortgage rates, by as much as 1.5 percentage points over the next 12 months. The good news is that the economy is in good shape, Guatieri added, citing recent data suggesting exporters are coping with the dollar’s latest run- up.
“ Our sense is that we will probably see above- potential growth in the second half of the year.”
Avery Shenfeld, senior economist at CIBC World Markets, agrees that pushing up still- low interest rates poses little risk to growth.
“ It could become more risky if the U. S. economy slows more materially next year.” The Canadian dollar rose 0.05 of a cent ( U. S.), to close at 84.86 cents, despite another day of falling crude oil prices.