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18 Jun

Bank of Canada May Soften Interest Rate Hike Warning

General

Posted by: Mike Hattim

By Les Whittington
Moneyville

OTTAWA—Despite repeated Bank of Canada warnings of higher interest rates to come, Canadians are unlikely to see an uptick in borrowing costs for many months as the world business climate weakens.

With Europe in financial turmoil, central bank governor Mark Carney is almost certain Tuesday to keep the bank’s trend-setting overnight rate at 1 per cent.

But the rate-setting announcement will be closely watched to see how Carney handles the balancing act created by the need to keep inflation in check without allowing Canada to be dragged down by weakening economic conditions abroad.

In his last rate decision in April, Carney caused a stir in financial circles by hinting that it “may become appropriate” before long to push up interest rates—a warning that reflected concerns about inflation and risky levels of Canadian household debt fed by historically low borrowing costs.

But the ground has been shifting under Carney’s feet in recent weeks. The recovery in the United States remains tentative, growth is slowing in emerging market giants China, India and Brazil and Europe is once again teetering on the edge of a financial meltdown that would damage economies everywhere.

Also, Canada’s economy grew by only 1.9 per cent on an annualized basis in the first three months of this year, well below Carney’s estimate of 2.4 per cent in 2012.

Overall, the deterioration of the outlook is so sharp it has prompted speculation that the Bank of Canada might do an about-face and cut interest rates later this year.

But, with borrowing costs already near historic lows, economists say such a move seems unlikely barring a steep economic downturn.

“I don’t think the Bank of Canada has gone as far as the market, which is actually pricing in some odds of a rate cut down the road,” said CIBC World Markets chief economist Avery Shenfeld.

He said Tuesday’s statement “will have to recognize some of the deterioration outside of Canada” but Carney may repeat language used in previous announcements to keep Canadians aware of his intention to raise rates as soon as possible.

“There may be some wording that reminds markets that, whenever it comes, the next move is probably still a rate hike,” Shenfeld commented.

While most economists say an uptick in the central bank’s key rate is out of the question this year, TD Bank says Carney could still defy expectations and start ratcheting up borrowing costs this fall.

“If we think about domestic conditions, interest rates are already at incredibly low levels and we’re having at least close-to-trend economic growth,” TD economist Diana Petramala said. “And household credit has bounced back in recent months. So, domestic conditions may warrant even higher interest rates.” However, she said this forecast hinges on the avoidance of a deeper financial crisis in Europe.

If Carney has to back away Tuesday from his April 17 warning that higher rates are coming, it will be the second time in a year he has been forced to do so. Last July, he issued a similar warning. But that intention was derailed by the financial upheaval in Europe in late 2011.

The central bank has kept its trend-setting rate at 1 per cent since September 2010 to try to shore up the economic recovery in Canada.