The Bank of Canada said Tuesday it sees “modest” rate increases in the medium term as the central bank raised its key interest rate to 3.5 per cent from 3.25 per cent, the fourth increase in a row.
Tuesday's hike was widely expected by economists.
In a shift in language, the central bank said it sees modest rate increases in the months to come. That contrasts with its December statement, which said “some further reduction in monetary stimulus will be required” in the next four to six quarters. The shift signalled the bank may slow the pace of increases this year.
“The use of the word ‘modest' would be designed to defuse any expectations that the bank would be looking at aggressive rate hikes,” said Marc Lévesque, chief strategist at TD Securities in a note, though he still expects the rate to hit 4 per cent by April.
The Canadian dollar weakened to 86.71 cents after the announcement from 87.01 cents Monday, because fewer rate increases would make interest-bearing Canadian securities less attractive and reduce demand for the currency.
“Some modest further increase in the policy interest rate would be required to keep aggregate supply and demand in balance and inflation on target over the medium term,” the bank said in a statement.
The central bank began raising rates in September to keep inflation at bay as the economy operates at full capacity. The rate now stands at its highest level since October, 2001.
In Tuesday's release, the bank said consumer price inflation, at 2.3 per cent in the fourth quarter, was lower than the bank had expected, mostly because of lower gasoline prices. Core inflation and the level of economic activity at the end of the year was close to its expectations.
The bank said its outlook for growth and inflation in Canada is similar to its views in October.
“The bank continues to judge that the Canadian economy is operating at its production capacity and will grow roughly in line with production potential through 2007,” it said.
It sees inflation returning to the 2 per cent target by the first half of 2007. Risks to the bank's outlook remain balanced for 2006 and “tilted to the downside through 2007 and beyond.”
Most economists approved of today's move.
“Given the remarkable behaviour of inflation and the negative balance of risks for 2007 carried in its own forecast, we think it makes sense for the BoC to signify its intention to soon move to the sidelines,” said Stéfane Marion, an economist at National Bank Financial, in a research note.
Further details on today's decision will come Thursday with the release of its monetary policy report update.
Central bankers make their next interest-rate announcement on March 7.
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