Canadian rate hikes: The threat increases

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If the threat of an interest rate increase is all that the Bank of Canada has in its monetary policy arsenal right now, at least that threat is being ratcheted up, thanks to the Organization for Economic Co-operation and Development.

The OECD is urging the central bank to raise its key rate by a quarter percentage point in the autumn, followed by quarter-point bumps every quarter to the end of 2013. The result: A key rate of 2.25 per cent, up from 1 per cent today. The OECD is stepping into the fray because of rising Canadian debt loads, driven by an unsustainable housing market.

As OECD's senior economist Peter Jarrett put it: "We feel that at least in the hottest real estate markets, particularly Toronto, that [rate hikes]would be a good signal that people should think twice about continuing to leverage up in order to buy more house than maybe they really need."

It is easy to get defensive about an outside organization trying to influence domestic monetary policy. In the Globe and Mail, Richard Ivey School of Business professor Mike Moffatt argued that the OECD's call was wrong – don't raise rates until at least 2013, he said – and his piece carried the headline, "OECD urges rate hike: Hey, mind your own business."

But you do have to wonder whether the OECD is the Bank of Canada's greatest ally right now. The central bank has a big problem with implementing rate hikes: The domestic economy isn't exactly purring, the global economy remains on shaky ground, the U.S. Federal Reserve has said that its own key interest rate would remain exceptionally low through at least 2014, and the Canadian dollar – already near par with the U.S. dollar and weighing on Canadian export might – would only rise more if Canadian interest rates moved higher.

Yet, doing nothing – the key rate has been 1 per cent since September 2010 – is sending Canadian home prices to dangerously high levels, which leaves the Bank of Canada in a bind. The solution? Talk up the threat of rate hikes without actually implementing them. It did so in its recent monetary policy report, and the Canadian dollar took the threat seriously. Now, using the OECD as a bad-cop sidekick, gives the central bank's threat added heft.