March 12, 2010
Economic Snapshot
Expect higher interest rates at mid-year, possibly before
JOHN CLINKARD
consulting economist, CanaData
Two recent developments point to higher interest rates in the not-too-distant future. First, according to Statistics Canada, the economy grew at a much faster pace (5.0%) in Q4/2009 than was expected by most analysts and, most important, by the Bank of Canada.
As frequently happens in the early stages of a business cycle upturn, most economy watchers are focusing on data that is a couple of months old and therefore has not yet started to reflect strengthening demand and output.
The second indicator pointing to the possibility of higher rates is the Bank of Canada’s latest policy interest rate announcement.
Although the BOC did not explicitly indicate it was going to raise rates in the current quarter, it reaffirmed its commitment, conditional on the current outlook for inflation, to hold the policy rate at its current level until the end of the second quarter.
Moreover, a number of statements contained in the BOC’s press release suggest it was more concerned about the stronger than expected pattern of inflation and, by implication, more predisposed to raising rates than at any time in the past year and a half.
Indeed, the BOC said that: “Core inflation (currently at 2%) has been slightly firmer than (it had) projected, the result of both transitory factors and the higher level of economic activity.”
In addition, the BOC removed a statement that it has included in the past seven policy interest rate announcements; something to the effect of: “The overall risks to its inflation projection are tilted slightly to the downside.”
As noted above, taken by themselves, these two developments do not suggest that the BOC will raise rates in the current quarter.
However, in conjunction with other recent indicators of stronger activity in the U.S. — including industrial production, up by a very strong 0.9% in January — and a stronger than expected ISM non-manufacturing report for February, these developments reinforce the view that the BOC will start to tighten policy at mid-year.
In addition, if core inflation continues to ratchet higher, there is an increased risk that the BOC will raise rates sometime in the second quarter.
John Clinkard has over 30 years’ experience as an economist in international, national and regional research and analysis with leading financial institutions and media outlets in Canada.
Note: The core inflation rate excludes the eight most volatile items and the effect of indirect taxes.
Data sources: Statistics Canada and Bank of Canada. Chart: Reed Construction Data – CanaData.
