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FYI
Central bank pulls trigger, raises key rate again
By TERRY WEBER
Globe and Mail Update
The Bank of Canada raised interest rates by a quarter percentage point Tuesday, saying inflation in this country remains stubbornly high while risks posed by world events are diminishing.
Tuesday’s decision leaves the central bank’s key target for the overnight rate at 3.25 per cent. Within minutes of the decision, Canada’s big banks started to raise borrowing costs. Royal Bank of Canada was the first out of the gate, hiking its prime rate to 5 per cent from 4.75 per cent effective Wednesday. Canadian Imperial Bank of Commerce quickly followed suit as did Bank of Nova Scotia, Toronto-Dominion Bank and Bank of Montreal.
“Since the Bank’s last interest rate announcement on 4 March, both core and total [consumer price inflation] inflation have remained well above the Bank’s 2 per cent inflation target and measures of inflation expectations have edged up,” the central bank said.
“Economic growth in Canada in the second half of 2002 and in early 2003 eased from its earlier vigorous pace, but domestic demand has remained firm and employment gains have continued.”
As a result, Canada’s economic activity is now nearing capacity.
The bank last raised rates in March, making the only central bank in a major industrialized country to tighten the reins so far this year. It had been on the sidelines since last fall after having delivered three increases earlier in 2002.
Economists had been sharply divided on what the bank would do in its most recent fixed-date policy announcement, although as Tuesday’s announcement neared increasing numbers were looking for a rate hike.
In Tuesday’s statement, the bank said the near-term outlook for both the global and Canadian economies is “somewhat weaker” than at the time of its last rate announcement.
“Nonetheless, with geopolitical uncertainties diminishing and world oil prices declining significantly, the risks confronting the global economy are now better balanced,” the bank said.
“The Bank thus expects that economic expansion in Canada and the United States will begin to strengthen towards the end of 2003 and will strengthen further in 2004.”
The bank’s next fixed-date policy announcement is in June. It releases its monetary policy update, however, later on April 23. That report will elaborate further on the bank’s expectations for both the economy and inflation.
Tuesday’s announcement gave the loonie a lift. By 10:30 a.m. EDT, the dollar had recouped early morning losses and was trading up 0.07 cents at 68.86 cents (U.S.).
Despite the relatively hawkish tone of the bank’s statement, Royal Bank assistant chief economist Derek Holt noted that the bank concluded by “cautiously observing that near-term economic uncertainties bear constant monitoring” and that the economy will likely continue near capacity into 2004 rather than warning of future rate hikes.
“What may make for a more cautious central bank is that an appreciating Canadian dollar reinforces the cooling effects of rate hikes,” he said.
“All fundamentals appear to be working in favour of Canadian dollar appreciation, including rising interest rate spreads over the United States, expectations for further strength in commodity prices, stronger government finances compared to the United States, and a far healthier trade account than record trade deficits stateside.”
Bank Governor David Dodge has repeatedly said rates in this country, which continues to log a solid economic performance relative to the rest of the world, must continue to rise.
But at least some analysts had argued that the bank was more likely to sit this one out because of the uncertainty brought on by the U.S.-led war in Iraq and softer economic growth elsewhere in the world, particularly in the United States. The outbreak of the SARS virus and its potential to effect on the Canadian economy also raised concerns for some economists.
An early survey by Reuters News Agency had indicated a slim majority of bond dealers expected the bank to stand pat on rates after delivering a quarter percentage point increase in March. However, a subsequent poll conducted just before Tuesday’s announcement showed the tables had turned, with the majority expecting the bank to hike rates.
In the most recent survey, eight of 13 polled said they expected a quarter point hike.
But, J.P. Morgan economist Ted Carmichael said Tuesday the wording of the bank’s latest statement suggest that it may be done tightening for the time being. Mr. Carmichael also noted that virtually all of the bank’s statements over the last year have referred to the necessity for future rate hikes to address inflationary concerns. That statement, however, was missing from Tuesday’s fixed-date policy announcement.
“The absence of this phrase suggests that the Bank is now more confident that inflation will fall back to the 2-per-cent target over the coming year,” he said.
February’s annual rate of inflation – the most recent data available - hit a 12-year high of 4.6 per cent.
The Bank of Canada has set a 1 per cent to 3 per cent target on inflation and has repeatedly vowed to act in order to contain price pressures. Mr. Dodge again warned during a speech in Washington last week that rates would have to rise to head off price pressures.
However, the bank has also been mindful of the risks posed by outside forces to the Canadian economy.
The United States – Canada’s biggest trading partner – continues to struggle to find its economic footing and that situation has started to show up in Canada’s economic reports, most recently in the latest international trade data that showed a narrowing trade surplus in February.
A big factor for forecasts leading up to Tuesday’s announcement has also been the length of the current U.S.-led war in Iraq, which now appears to be winding down. In its last rate decision, the U.S. Federal Reserve took the unusual step of declining to even characterize that country’s short-term economic prospects because of the uncertainty surround the world’s political situation.
The International Monetary Fund, in its latest global outlook, also cautioned that the conflict’s impact could slow world economic growth, although it also noted that it expects Canada’s growth to continue to lead Group of Seven nations.
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