BoC raises rates, cuts growth forecast

OTTAWA - The Bank of Canada scaled back expectations for economic growth Tuesday while going further out on the interest rate limb with its second quarter-point hike in as many months.

OTTAWA - The Bank of Canada scaled back expectations for economic growth Tuesday while going further out on the interest rate limb with its second quarter-point hike in as many months.

The central bank issued what economists called a "dovish" statement on the global and Canadian growth, but maintained the domestic economy was sufficiently healthy to withstand raising the trendsetting rate to 0.75 per cent.

The Canadian dollar jumped 0.91 of a cent to 95.71 cents U.S.

The rate hike will have an impact on variable-rate loans as the big commercial banks began raising their prime rates by a quarter point shortly after the announcement.

The prime rate increased to 2.75 per cent from 2.5 per cent, increasing the cost of consumer and car loans and variable mortgages tied to prime.

For example, a quarter-point increase in mortgage rates will add about $46 a month, or $550 a year, for a home owner who has a $340,000 mortgage for a 35-year term. It's about $90 per month higher than six months ago when interest rates were half a point lower.

But Laura Parsons, a mortgage expert at Bank of Montreal (TSX:BMO), noted that borrowing costs remain at near historic lows.

"It's a buyers' market and the rates are still really good. That's the problem, we've forgotten what a bad rate looks like," she said.

And while variable rates rose, there was evidence longer-term interest rates might slide moderately because of the central bank's gloomier outlook, said CIBC chief economist Avery Shenfeld.

The vast majority of economists had predicted the rate move — while a few speculated bank governor Mark Carney might hold back if he felt economic growth was slowing.

Carney's governing council scaled back the bank's previous call on growth by two-tenths of a point to 3.5 per cent this year and 2.9 per cent next.

But that didn't stop the central bank from following through on the hike, although it cast new doubts about the pace of monetary tightening in future announcements.

The key, said economists, is the bank's new estimate that will take until the end of 2011 for the economy to reach potential, two quarters later than previously projected.

BMO Capital Markets economist Michael Gregory said Carney gave himself an extra six months to return rates to normal levels, which he said would be in the two-to-three per cent range. Gregory agreed with the bank that a modest hike now was appropriate.

"There are risks posed by rates being too low for too long and I believe those risks are beginning to crystallize. When credit is cheap, people consume more of it than perhaps is optimal over the long haul," he said.

Stephen Lingard of Franklin Templeton Managed Investment Solutions suggested Carney likely wanted to build himself some manoeuvring room should he need to cut rates in the future.

"What central bankers don't want is a situation like Japan where policy rates are at zero and they have no ammunition left to stimulate the economy," he explained.

The central bank's governing council offered no hint Tuesday that they believed a severe enough slowing, necessitating a second round of monetary stimulus, was in its forecast. It did, however, flag several weaknesses globally and domestically that will keep growth moderate.

The council referred to uncertainty over sovereign debt issues in Europe, "uneven" private demand in the United States and a global recovery that is not yet self-sustaining.

In Canada, the council said the recovery is still being led by government and consumer spending, but noted housing has slowed, and while employment growth remains strong, business investment is being held back by global uncertainties.

"This revision reflects a slightly weaker profile for global economic growth and more modest consumption in Canada," the bank said.

Still, several analysts worried about the impact of higher rates on a slowing economy. With the exception of employment, which advanced a whopping 93,000 in June, most major economic indicators have pulled back, particularly housing.

"Hopefully the Bank of Canada will be very cautious in any decisions to continue to raise rates in the coming months in light of unstable global economies and the various risks that exist in today's economic environment," said Queen's University business professor Sean Cleary.

Although growth will be slower in the next two years, the bank did lift its projection for 2012 to 2.2 per cent from the 1.9 per cent it had earlier forecast.

— With files from Sunny Freeman in Toronto

 
 
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