A relatively strong Canadian economy will force the Bank of Canada to double its key lending rate by the end of the first quarter in 2012, says a new report from Citigroup Capital Markets.

The country’s central bank will stand pat when it announces its latest rate decision on Tuesday but come October it will begin a tightening campaign that will see rates jump 100 basis points in about six months, said Todd Elmer, a foreign exchange analyst at Citi.

Mr. Elmer said the Street’s presently downbeat rate expectations stem mostly from external factors – presumably the European sovereign crisis and waning U.S. recovery –  and poorly reflect Canadian data that has consistently exceeded expectations.

“This means that there is still some time before the BoC may need to explicitly signal a hike, but with limited spare capacity in the economy, we doubt there is sufficient breathing room for the Bank to adopt a more dovish stance.”

Some worry that a rate hike in Canada at a time when U.S. monetary policy is turning more dovish could drive the loonie higher to the detriment of growth.

But Mr. Elmer said the market has tended to overestimate the drag from the currency on both the real economy and price.

Despite persistent Canadian dollar strength, he noted that Citi’s economic surprise index for Canada has moved sharply higher recently as has the bank’s inflation surprise index.

“This skews risks in favor of a more hawkish statement from the BoC and Monetary Policy Review this week and a potential rise in interest rate expectations,” he said.