Bank of Canada may tip hand about 2011 rate hike this week
By Paul Vieira, Financial Post December 5, 2010
OTTAWA — The suspense building up to Tuesday’s Bank of Canada rate decision revolves around whether the central bank will say anything in its statement to nix market expectations for a rate hike in early 2011.
Despite a week of data that suggested there’s a significant slowdown underway in Canadian economic activity, fixed-income markets continue to price in 50-50 odds for an increase in the central bank’s key policy rate in March, and a 100 per cent chance that happens in April.
Yet, most economists at Canada’s big banks don’t envisage a rate hike until July, given recent weakness in trade and real estate investment and the uncertainty sparked by the re-emergence of Europe’s debt woes.
“It is possible the Bank of Canada will take on a more dovish tone in this statement, simply because the market has been a bit aggressive in pricing in (monetary policy) tightening,” said Douglas Porter, deputy chief economist at BMO Capital Markets.
The yield on the two-year Government of Canada bond, viewed as a proxy as to where the central bank rate is headed, climbed steadily in November on improving economic data in the United States and elsewhere, hitting a high on Nov. 25 of 1.74 per cent but had dropped slightly to the 1.6 per cent range as of last Friday.
Compounding matters, however, was an inflation reading in October that surprised on the upside, with headline and core readings both rising 0.4 per cent on a month-over-month period, to hit annual rates of 2.4 per cent and 1.8 per cent, respectively. The central bank sets policy to hit and maintain annual inflation of two per cent.
“I don’t know if the Bank of Canada knows what it is going to be doing next spring to talk confidently at this point,” said Avery Shenfeld, chief economist at CIBC World Markets.
Views vary over how quickly the Bank of Canada will move to raise its key rate in 2011. The C.D. Howe Institute’s monetary policy council, made up of
Bay Street economists and academics, are divided as to what happens to the benchmark rate six months from now, with opinions ranging from one per cent, or unchanged, to as high as 2.25 per cent.
Weaker third-quarter GDP data — at one per cent annualized below the central bank’s forecast of 1.6 per cent — and mixed-to-disappointing November labour figures have provided fresh ammunition for those who believe the central bank should remain on an extended rate-hike hiatus.
One analyst, David Madani of Capital Economics, has mused that central bank governor Mark Carney might need to consider cutting rates.
He said he hopes the language in the central bank’s rate statement regarding output growth and projected inflation “be softened to reflect the disappointing tone of the incoming data.”
He added the present central bank forecast of 2.6 per cent annualized growth in the final three months of 2010 “now looks far too optimistic,” especially after data revealed the economy contracted in October.
Furthermore, analysts say the Bank of Canada may remain cautious on rate hikes so long as the Federal Reserve forges ahead with its $600-billion US asset-purchase plan — which will keep the loonie elevated and, hence, make sales abroad that much tougher. (Net trade was a massive drag on third-quarter growth.)
Those who expect a rate hike early in 2011, however, argue the central bank’s Tuesday statement will likely highlight the improving economic data globally — from Asia to Germany and the United States, the non-farm payrolls notwithstanding — to offset some of the weaker domestic readings.
Stewart Hall, economist at HSBC Securities Canada, said the central bank likely remains concerned about the record levels of household debt. And the GDP report highlighted a drop in the quarter in the savings rate, to 3.3 per cent from 6.1 per cent in the preceding quarter.
“That is certainly an element at work in the policy mix,” said Mr. Hall, who has predicted a March rate increase.