Rate hikes are coming sooner rather than later

OTTAWA — The Bank of Canada signalled Tuesday that it will look for an opportunity to raise interest rates sooner rather than later to keep inflation in check as the Canadian economy continues to grow.

OTTAWA — The Bank of Canada signalled Tuesday that it will look for an opportunity to raise interest rates sooner rather than later to keep inflation in check as the Canadian economy continues to grow.

The central bank kept its overnight rate target at one per cent but noted that the U.S. economy has grown at a slower pace than expected and Europe faces a growing credit crisis — both potential drags on the domestic economy.

Despite those threats, the bank said it believes Canada’s economy remains on track to grow this year, which observers said likely means a rate hike as early as October .

CIBC World Markets chief economist Avery Shenfeld said the bank’s decision to drop the word “eventually” in reference to the timing of its next rate hike suggests it will move before the end of the year.

“The underlying message is that rate hikes will be coming sooner than eventually,” Shenfeld said.

“The surprise is really for those who thought that the Bank of Canada would be waiting until 2012 to begin hiking rates, because I think here the message is directed at those dovish observers and indicating that we will probably be moving sooner than that.”

The suggestion that rates in Canada will rise in the near term helped push the loonie up 0.88 of a cent to 105.17 cents U.S. — the highest close since the end of April.

Canadian economic growth slowed in the second quarter, but the central bank said it expects to see an acceleration in the second half of the year.

Overall, the Bank of Canada expects the economy will expand by 2.8 per cent in 2011, compared with its call in April for 2.9 per cent growth. The outlook for 2012 and 2013 was unchanged at 2.6 per cent and 2.1 per cent respectively.

Shenfeld said the central bank will likely wait to see if its economic outlook is on track before moving to raise rates.

“The key is the Bank of Canada has to see evidence that its projection for a re-accelleration in economic growth is actually taking place,” said Shenfeld, who currently expects the central bank to hold rates in September and move in October.

BMO Capital Markets senior economist Michael Gregory said the case of a rate hike was building, noting that household spending in Canada remains solid.

“We are sticking to our call for October and December rate hikes this year,” Gregory wrote in a note to clients.

However TD Bank economist Sonya Gulati said she continued to expect the Bank of Canada to keep rates on hold until its first meeting in 2012.

“We think that they are going to time it more to when the (U.S.) Fed is going to start to increase it, which we think is going to be March of next year,” she said.

“In previous communications, the governor has indicated that the rate spreads between the two countries is something he’s keeping a close eye on and that there has to be a working gap between the two for the countries to go forward, given how high the Canadian dollar is.”

Gulati said TD expects the Bank of Canada will increase its overnight rate target in one-quarter percentage point intervals starting in January to two per cent before pausing to assess the situation and then increasing the key rate again to three per cent by the end of 2012.

A full update on the central bank’s outlook for the economy and inflation is expected when the Bank of Canada publishes its monetary policy report on Wednesday.

The central bank said in its statement Tuesday that the U.S. economy continues to be restrained by the consolidation of household balance sheets and slow growth in employment while fiscal austerity measures in Europe also restrain growth.

“Widespread concerns over sovereign debt have increased risk aversion and volatility in financial markets,” the central bank said in its statement.

The central bank also said its outlook assumes that European authorities will be able to contain the sovereign debt crisis, “although there are clear risks around this outcome.”

However as Europe and the United States continue to put up warning signs, the Canadian economy has appeared to be on track with three consecutive months of job growth and signs of inflation.

Statistics Canada said Tuesday that its composite leading index rose 0.2 per cent in June compared with a 0.8 per cent gain made in May.

The agency said a downturn in the auto sector due to disruptions following the earthquake and tsunami in Japan temporarily slowed assembly work in Canada, while the housing index increased 0.3 per cent as home starts in June hit a high for the year to date.

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