Bank of Canada hikes rates; likely more in store
Reuters, 25 April 2006
By Louise Egan
OTTAWA, April 25 (Reuters) – The Bank of Canada hiked its key overnight interest rate on Tuesday for the sixth straight time, maintaining its bias toward further increases as it warned the economy may be growing a shade faster than desired.
The bank raised the rate by 25 basis points to 4 percent as expected, but cautioned it would monitor developments closely "in light of the cumulative increase in the policy interest rate since last September." The bank said: "In line with the Bank's outlook for the Canadian economy, some modest further increase in the policy interest rate may be required to keep aggregate supply and demand in balance and inflation on target over the medium term." Analysts saw a slightly more hawkish central bank poised to take rates at least one notch higher, inching closer to the U.S. Federal Reserve's 4.75 percent rate.
The Canadian dollar rallied to C$1.1340 to the U.S. dollar, or 88.18 U.S. cents, at 10:15 a.m., from C$1.1373, or 87.93 U.S. cents, just before the rate announcement. The prospect of higher Canadian interest rates makes Canadian interest-bearing assets more attractive. But the carefully balanced wording of the bank's statement also hinted at a possible pause in the tightening cycle.
"I think what they want to do over the coming months is take stock and really see how those rate hikes had an impact on the economy," said Gareth Sylvester, senior foreign exchange consultant at HIFX Inc. Given the bank's fretting over signs of a slightly overheated economy, the Bank of Montreal said it expects two more rate increases this year up to 4.5 percent. "The bank is probably a little more concerned about the inflation outlook than was the case previously," said Sal Guateri, senior economist at the Bank of Montreal. The economy is "operating at, or just above, its production capacity," the central bank said, whereas in March it said it was at capacity.
FUTURE RISK MILD
At the same time, the central bank was slightly more optimistic on future risks from an unwinding of "global imbalances," the catchphrase used to describe the trade and investment gap primarily between Asian economies and the United States. "The bank judges that the risks to its projection are roughly balanced, with a small tilt to the downside later in the (2006-08) projection period." Previously, the BoC had spoken of balanced risks for 2006 and risks being tilted to the downside from 2007 onwards.
The global economy was showing a little more momentum than anticipated, the bank said, as data from major economies showed a sharp pickup in activity from the end of last year. Robust global growth and high prices of Canadian commodities have fueled domestic growth, in line with the bank's January outlook.
However, several sectors are still feeling the sting of the appreciation of the Canadian dollar CAD and global competition, the bank said. It projected total inflation averaging close to its 2 percent annual target in 2007 and 2008, excluding any effect from the new Conservative government's plans to cut the federal sales tax. The government will present its maiden budget on May 2. The bank's measure of core inflation, which excludes volatile items like energy and some foods, came in a notch higher than expected in March at 1.7 percent on the year, but still under the target. High energy prices have pushed the total annual inflation rate to slightly above the target. The bank upgraded its forecast for 2007 growth to 3.0 percent from 2.9 percent and issued its first 2008 forecast of 2.9 percent. It pegged this year's growth at 3.1 percent. (Additional reporting by the Toronto Treasury Desk)
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