October 23, 2012 / 1:17 PM / 5 years ago

Bank of Canada surprises with more rate-hike talk

4 Min Read

A sign framed by maple leaves is pictured in front of the Bank of Canada building in Ottawa July 17, 2012.Chris Wattie

OTTAWA (Reuters) - The Bank of Canada surprised markets on Tuesday by largely keeping a bias toward higher interest rates and issuing a fairly upbeat outlook on growth, adding for the first time that soaring household debt could justify eventual rate increases.

The central bank, which has held its key rate at 1.0 percent for two years, continued to use the hawkish language that has made it an outlier among the central banks of major economies. It softened its tone only slightly by making the timetable for rate hikes less definite.

The bank has frozen rates for two years but since April has defied the global trend by signaling plans to eventually tighten monetary policy.

Markets had been primed for softer language this week or even a shift into a neutral stance after a speech by Bank of Canada Governor Mark Carney last week that was seen as decidedly more dovish.

"All in all, the Bank of Canada continues to be one of the most hawkish central banks in the advanced economies," said Camilla Sutton, chief currency strategist at Scotiabank.

Previously, the bank had made rate hikes conditional on excess supply in the economy being absorbed, a way of saying growth in gross domestic product would have to be 2 percent or higher, a scenario which is seen as increasingly unlikely as growth slows.

That reference was dropped on Tuesday.

"Over time, some modest withdrawal of monetary policy stimulus will likely be required, consistent with achieving the 2 percent inflation target," the bank said in its rate statement.

Still, the bank appeared intent on telegraphing that rates will go up, not down, even in the face of global uncertainty.

"We thought they'd water it down a bit. But from some angles, this actually isn't watered down much at all," said Doug Porter, deputy chief economist at BMO Capital Markets.

The Canadian dollar firmed against the U.S. currency after the rate statement. The currency traded as strong as C$0.9909 to the greenback, or $1.0092, compared with C$0.9970, or $1.0030, just before the statement.

Overnight index swaps, which trade based on expectations for the central bank's key policy rate, showed that after the announcement traders resumed placing small bets on the possibility of a rate hike in 2013.

Analysts in a Reuters poll last week forecast the bank would wait until the fourth quarter of next year before raising rates, two quarters later than the forecast in a similar poll in August.

Debt a Top Concern

Flagging its alarm over Canada's record high household debt-to-income ratio, the bank said for the first time that personal debt would play a key role in monetary policy decisions as part of its evaluation of domestic and global developments.

"The phrase about the household sector is new. Its focus is on the household debt burden, a more hawkish tilt," said Jonathan Basile, director of economics at Credit Suisse Canada.

The bank's growth and inflation outlook for Canada was slightly more downbeat. It now sees the economy returning to full capacity by the end of 2013. In July, it had forecast that would happen in the second half of 2013.

The bank sees total inflation rising back to its 2 percent target by the end of 2013 instead of the third quarter of that year and sees exports returning to their pre-recession peak in the first half of 2014 instead of at the beginning of that year.

Its predicts growth this year of 2.2 percent, but the projection is not comparable to its previous forecast of 2.1 percent because they take into account Statistics Canada's historical revisions to gross domestic product data. It predicts growth of 2.3 percent and 2.4 percent in 2013 and 2014, respectively.

Additional reporting by Andrea Hopkins, Claire Sibonney and Alison Martell; Editing by W Simon; and Peter Galloway

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