Thursday, March 25, 2010

INTEREST & INFLATIONARY OUTLOOK


Rate speculaton rises after BoC governor highlights inflation threat
Paul Vieira, Financial Post
Published: Wednesday, March 24, 2010

OTTAWA -- Canadians could face higher interest rates within the next few months, Bay Street economists said Wednesday after Bank of Canada Governor Mark Carney said inflation is "slightly firmer" than expected and that the promise to hold rates at record lows until July was only conditional.

Mr. Carney's comments during an Ottawa luncheon speech - in particular how he emphasized, against a backdrop of improving economic conditions, that his rate commitment was "expressly conditional" - led analysts to revisit their rate outlook, and pencil in the possibility of a move as soon as June.

The central bank's next rate announcement is April 20, followed two days later by its updated economic forecast. After that, there are rate announcements June 1 and then July 20.

The consensus among private-sector economists was for the central bank to honour its pledge and begin rate hikes in July. Now, some aren't sure. Bond traders, meanwhile, Wednesday pushed up yields on two-year notes in anticipation of rate hikes in the coming months.

The governor's remarks "failed to quell the market's speculation that a June rate hike may be in the cards," said Eric Lascelles, chief economics and rates strategist at TD Securities. "In fact, [Carney] goes to quite some length to emphasize the conditionality of the commitment not to raise rates before mid-2010, damning it with faint praise."

In the speech, Mr. Carney said inflation has been higher thanks to "transitory factors," most notably the Olympic Games in Vancouver last month, and a higher-than-expected level of economic activity. Later, speaking to reporters, the governor added first-quarter annualized growth is "looking stronger" than the central bank's projection of 3.5%. That would follow robust expansion of 5% in the final three months of 2009.

The Bank of Canada's last economic outlook, tabled in January, envisaged core inflation to average 1.6% in the first quarter and 1.7% in the second quarter. But in January, core inflation came in at 2%, and last month advanced 2.1% year-over-year.

The central bank sets its policy rate with a goal of hitting, and maintaining, 2% inflation.

The inflation outlook would be updated in April. At that time, the central bank would "take judgments on the appropriateness" of its conditional pledge, the governor told reporters.

"I cannot imagine a lower inflation forecast being unveiled come April," said Derek Holt, vice-president of economics at Scotia Capital, "but I can easily see a forecast for core inflation to remain at the 2% target that would imply earlier than anticipated hikes."

Mr. Holt said the central bank could raise its benchmark rate either in April or June, with an increase of 50 basis points to "punctuate" its seriousness in containing inflation and move away from emergency-level rates.

In April of last year, Mr. Carney cut the bank's key lending rate to its lowest possible level, 0.25%, and pledged to keep it there until the end of the second quarter in 2010. This was in an effort to pull the economy out of a deep recession, and get inflation up toward to the bank's preferred 2% target by mid-2011.

In recent weeks, however, data suggest the economic recovery is moving at a roaring pace, far exceeding expectations.

Another factor that could prompt an earlier-than-expected rate hike is an increase in M3, a key measure of money supply, said Stewart Hall, economist at HSBC Securities Canada. So far, month-over-month growth rates are tracking higher than the pre-crisis 12-month average.

"All that liquidity that has been injected into the financial system, rather than gathering dust, is now beginning to make it into the economy," Mr. Hall said. "And perhaps more than some slight upside on core inflation, it may be M3 growth that may be causing the central bank some angst with regards to their inflationary outlook."

Photo by: rian_ bean

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