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Bank of Canada Governor Mark Carney (Sean Kilpatrick/The Canadian Press)
Bank of Canada Governor Mark Carney (Sean Kilpatrick/The Canadian Press)

Rate expectations send dollar soaring Add to ...

The Bank of Canada is sending a clear message that interest rates could rise as early as June, signalling a turning point in the recovery and triggering a debate on how fast and how high rates will move.

The central bank kept its key rate steady at the rock-bottom level of 0.25 per cent at its policy meeting Tuesday, but removed key language that had pledged to keep the benchmark at current levels through the middle of the year.

That move contributed to growing expectations that the central bank will raise rates as early as June 1, its next policy decision, and sent the dollar soaring again.


The dollar jumped 1.58 cents to $1.0012 (U.S.) as investors bet interest rate increases in Canada will outpace those in the United States, where the Federal Reserve shows no signs of boosting rates any time soon.

With the timeline for a rate hike nearly set in stone, investors and economists are turning their attention to how fast rates will move.

Policy makers will end this year with a lending rate of 1.5 per cent, many economists believe, moving to between 2.5 and 3.5 per cent by the end of next year.

The level that most economists consider "neutral" is 4.5 per cent.

At the height of the global financial crisis in April, 2009, the bank had slashed its benchmark overnight rate to a mere 0.25 per cent, a measure aimed at providing stimulus to an economy coping with frozen credit markets, slumping demand for an array of goods and services, and rapid corporate job cutting.

"With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus," the Bank of Canada said in a statement Tuesday.

Economists pushed up their forecasts Tuesday in response to Bank of Canada Governor Mark Carney dropping his year-old pledge to keep the benchmark interest rate at 0.25 per cent through mid-2010 or later, depending on what happens with inflation.

Whether Mr. Carney begins lifting the rate at the June 1 meeting or at one of his subsequent decisions in July or September, he faces a tough balancing act. Moving too aggressively could stall or reverse a recovery that's the envy of the Group of Seven.

Smaller businesses are still having a tough time accessing credit, many consumers are saddled with more debt than they'll be able to handle at higher rates, the currency is already hovering around parity with the U.S. dollar, a coming sales tax threatens to cool demand for housing, and the U.S. Federal Reserve is at least a few more months away from its own first move.

Still, moving too slowly could conceivably send Canada's hotter-than-anticipated growth and inflation into overdrive and risk the type of asset bubbles that may be forming in nations such as China and Singapore - a less likely scenario but one that no inflation-targeting central bank can simply dismiss.

"There's a bit more risk in moving too quickly," Douglas Porter, deputy chief economist at the Bank of Montreal, said in an interview. "There doesn't seem to be any serious inflation risk in the U.S. at this point, and it's tough to see a major outbreak of inflation in Canada if you've got inflation going nowhere in the U.S." As a result, Mr. Porter said, the central bank will likely move in increments of 25 basis points and may pause after a few moves to re-evaluate, at least until the Fed starts raising rates. At that point, with less fear of sending the loonie soaring, Mr. Carney might "crank it up a notch" and tighten in larger chunks if needed, he said.

Mr. Carney dropped a tell-tale hint Tuesday that reliably low rates have spurred more borrowing and spending than the central bank had expected they would.

The emergency rates worked better than those in the United States at stimulating the economy because banks were in better shape here and consumers were less worried about losing their jobs, so almost as soon as Mr. Carney greased the wheels, things started moving.

However, that cuts two ways.

"It will be even more effective on the way up, because of the vulnerability of consumers that are now carrying a lot of debt," Benjamin Tal, a senior economist at the CIBC, said in an interview. "The surprise will be how little it will take to slow down the consumer."

Indeed, even though the overall thrust of Mr. Carney's announcement Tuesday was more "hawkish," it was sprinkled with notes of caution.

Mr. Carney and his rate-setting panel said they expect the economy to return to full capacity in the second quarter of next year, rather than the third as previously forecast, and said the bank's preferred gauge of inflation will stay close to its 2-per-cent target until the end of 2012, a longer than policy makers projected in January, and from an earlier starting point.

But while they boosted their growth forecast for this year, the forecast for next year was cut from 3.5 per cent to 3.1 per cent, and the economy will grow by just 1.9 per cent in 2012, the bank said. All of that reflect nagging fears such as what will happens when government stimulus spending around the world gives way to painful debt-reduction measures, and that the high Canadian dollar could cause more pain for exporters.

"You have many, many forces that will slow down the economy without the Bank of Canada," Mr. Tal said.

With files from Reuters

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