Interest rate decision coming

It’s a blockbuster week for Canadian economic events, headlined by a long-anticipated announcement from the Bank of Canada on whether it will move interest rates higher.

It’s a blockbuster week for Canadian economic events, headlined by a long-anticipated announcement from the Bank of Canada on whether it will move interest rates higher.

Until recently, economists thought it was practically a certainty that the bank would up rates from historical lows of 0.25 per cent, where they have been since April 2009.

But doubt started to creep in over the last month as worries about the European government debt crisis started to escalate, which in turn helped drive stock markets sharply lower during May.

What started as concern over whether Greece could control its unsustainably high deficit has grown to worry about whether the euro currency itself can survive as countries mainly in southern Europe slash spending to lower debt.

Analysts have said that the central bank wouldn’t want to be seen raising rates at a time when financial markets are in turmoil.

“I’ve just seen the sentiment on this shift out dramatically and I hate to say it’s this simple but it is: it is whatever global stocks are doing,” said Doug Porter, deputy chief economist at BMO Capital Markets.

“If it looks like the markets are calming down and settling down then it just becomes no issue.”

But he added that surveys point to a 70 per cent chance the bank will up its key rate by a quarter point on Tuesday, “assuming nothing completely untoward happens to the markets in the next few days.”

But Porter added that apart from signs of real stress in financial markets, Canadian economic conditions have improved so much that the bank has to move.

For example, the bank will likely receive news on Monday that the overall economy continued to improve strongly during March when Statistics Canada releases its latest reading on gross domestic product.

“The early stages of the recovery were much stronger than anyone had really expected,” Porter said.

“If you had to wrap it up and tie it up in a bow as to why the bank should be hiking, I think the back-to-back GDP numbers of the fourth and first quarters provide as strong evidence as you need. We saw five per cent growth in the fourth quarter last year and we’re thinking it’s closer to six per cent in the first quarter.”

The Organization for Economic Co-operation and Development chimed in last week when the leading economic agency said that Canada should start raising rates immediately.

The OECD said that temporary stimulus measures such as low interest rates could overstimulate the economy if left in place for too long.

Porter expects that the increase will herald a string of increases that could see the Bank of Canada raise rates by almost two percentage points over the next year.

But no matter what the bank does on Tuesday, it’s not expected to have an effect on the Toronto stock market, where investors expect the bank to raise rates sooner rather than later.

“Whether the bank tightens (monetary policy) or not is not going to cause any sort of tremors in the market,” said Paul Vaillancourt, vice-president at Canadian Wealth Management in Calgary.

“Everyone expects that rates will soon start to trend higher. We expect that. I’m not sure we necessarily expect it as early as next week.”

Trading will likely be cautious in the coming week as the European government crisis continues to cast a pall over markets.

The Toronto market chalked up an advance of 150 points or 1.3 per cent at the end of a volatile trading week. But the TSX is down just over 600 points or five per cent from its 2010 high on April 26.

Employment data at the end of the week should also provide welcome distraction from the eurozone as both Canada and the United States release the latest employment data.

Porter observed that the Canadian economy is unlikely to repeat the strong showing from April when almost 109,000 jobs were created.

“We just had the single biggest monthly gain in employment on record in April,” he noted.

“Looking at the past record after a huge month of gains like that, there’s no clear pattern for the next month but suffice to say we can’t come close to matching those kind of gains.”

Porter expects to see a modest gain of about 20,000 jobs and a further decline in the jobless rate to eight per cent.

“I think the Canadian jobs recovery is real and we’re well on the road to recouping the job losses we had in the recession,” he added.

Porter also said the U.S. is likely in for another month of strong job gains after 290,000 jobs were created during April.

But, as in April, the overall number will look very impressive because of the huge amount of people being hired to conduct the 2010 census.

“We could have a job gain of about 750,000 or so,” said Porter.

“We think the (private sector) gain will be about 200,000 which would be quite respectable, not unlike what we saw in April. It’s not great but better than what we saw in the early stages of the last two recoveries.”