Bank of Canada surprises markets with hawkish tone

Tue Apr 17, 2012 3:33pm EDT
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By Louise Egan and Randall Palmer

OTTAWA (Reuters) - The Bank of Canada said on Tuesday it may need to start raising interest rates, preparing to lead the Group of Seven industrialized nations in lifting borrowing costs even as fears of a flare-up of the European debt crisis have not fully faded.

The central bank held its key overnight rate at 1 percent as anticipated but issued a surprisingly hawkish statement that included explicit language on eventual rate increases for the first time since last July.

"In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 percent inflation target over the medium term," the central bank said in a statement.

The language caught traders off guard, with Canadian dollar and rate futures both jumping following the statement.

The central bank described an economy that is at a turning point where inflationary pressures could become a concern and high household debt is the biggest risk.

It raised its growth and inflation forecasts for this year and said the economy will return to full capacity - the limit at which it can grow without generating excessive inflation - in the first half of 2013 rather than in the third quarter as it predicted in January.

The news prompted three of nine primary dealers surveyed by Reuters on Tuesday to pull forward their forecasts for a rate hike.

The median forecast is now for a hike in the first quarter of next year whereas a similar poll last month called for a hike in the third quarter. Five dealers have now pulled forward rate hike forecasts since that poll.   Continued...

The Bank of Canada building is pictured in Ottawa March 3, 2009. REUTERS/Chris Wattie (CANADA)