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Economists expect interest rate hike

OTTAWA - For such a close call, the opinion among economists is near unanimous.

OTTAWA - For such a close call, the opinion among economists is near unanimous.

By the time most Canadians get to work Wednesday, Bank of Canada governor Mark Carney will have made the cost of short-term borrowing a little dearer by hiking the trend-setting rate a quarter point to one per cent.

Three surveys of economists in the past week finds overwhelming majorities who believe the governor will hike rates a third time in as many months Wednesday morning.

And, after dipping to below 50 per cent, even the markets have priced in a 60 per cent probability of a hike.

But analysts also note that Carney likes surprises and this time he has plenty of reasons to buck expectations, particularly since he is the only central banker in the G7 that has shown such faith in the economic recovery.

Even supporters of a hike, like the Bank of Montreal's Douglas Porter, concedes the decision facing the bank is far from clear-cut, given the sharp downturn in growth in the United States and Canada in the spring and summer months.

If anything, it's the opponents of a rate hike who seem to be more sure of their position.

"Should (the central bank) raise rates. I'm clear the answer is no," says Avery Shenfeld, chief economist with CIBC World Markets.

"I think there's enough doubt about the speed of the recovery in North America that they should wait until October to see how the numbers roll out."

Shenfeld notes that when the Bank of Canada embarked on a tightening policy as far back as last April, the governing council had a very different expectation of how the recovery would unfold than what appears to be occurring.

In April, the central bank thought the economy would grow by a strong 5.8 per cent in the first quarter of 2010 — a forecast it got right — before slowing moderately predictions to a still acceptable 3.8 per cent, 3.5 per cent and 3.5 per cent advances for the next three quarters.

But the bank significantly downgraded its second-quarter projection in July to three per cent, although even that tempered forecast turned out to be overly rosy.

Last week, Statistics Canada reported the economy actually grew an anemic two per cent in the second quarter, while the last jobs report for July saw the unemployment rate edge north a tick to eight per cent. Meanwhile, the housing revival, which had been a key pillar of growth, has weakened.

The outlook is bleaker in Canada's biggest trading partner, where despite encouraging manufacturing numbers last week, the talk is of more not less stimulus. President Barack Obama is proposing US$50-billion in infrastructure spending, and Federal Reserve chairman Ben Bernanke is considering further quantitative easing.

Economists note the more Canada separates itself from rock-bottom rates in the United States, the greater the pressure on the Canadian dollar and the greater the harm to Canada's export-oriented manufacturers.

Some argue that Carney's tightening policies are already undercutting the economy.

Digging into the weeds of last week's gross domestic product numbers, "output was crimped in the two most interest rate sensitive areas of the economy: autos and housing," notes Carl Weinberg, chief economist with U.S.-based High Frequency Economics.

"Neither the slowdown in domestic spending on consumer goods and housing nor the rise of imports recommends more rate hikes," Weinberg adds, pointing out that the rise in imports and weak exports are partly attributable to the high dollar.

The case for one more tightening round is that while growth has slowed, Canada's economy continues to advance and, after being dormant for two years, business investment is now showing signs of life.

That's an encouraging signal that the private sector is ready to take over from government-led activity.

In addition, at one per cent, the policy rate would still be below inflation, and well below what would be considered a normal setting of three to four per cent.

Nor is there strong evidence the past two minor hikes have filtered through into the real economy.

Economists point out that while the central bank has the power to influence short-term rates, such as variable mortgages and lines of credit, longer-term mortgage rates have actually edged down.

Part of the weakening in the housing market was consumers moving up their purchases in anticipation of higher rates, says the Royal Bank's Paul Ferley, rather than the impact of higher rates. As well, given how strong the market had been, a slowdown was expected.

"Interest rates remain very low even with the hikes we've seen," he said.

But there is a limit to how far ahead of the U.S. Carney can go on interest rates, admits Ferley. He believes the bank governor will be reticent about tightening still further this year unless he sees clear evidence the American economy is out of danger.

 
 
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