January 15, 2014 / 10:19 PM / 4 years ago

Bank of Canada rates seen steady till 2015 despite dovish shift

5 Min Read

OTTAWA (Reuters) - The Canadian central bank's next interest-rate move will be a hike rather than a cut and won't happen until the second quarter of 2015, according to a Reuters poll of economists, though some predict the bank might sound more dovish in the interim.

The median forecast in a Reuters poll of 37 economists, released on Wednesday, was for the Bank of Canada to raise its main interest rate by 25 basis points at some point between April and June of next year.

None of the respondents expected a move at the bank's next decision date on January 22, and all but two expect the bank to hold the rate steady at 1.0 percent through 2014.

The poll results were unchanged from a previous Reuters poll on November 28, but the mood among some participants was decidedly more downbeat.

The tone of the bank's statement next Wednesday will be the focus of attention as well as its quarterly monetary policy report, which will be issued at the same time. In the report, the bank will weigh the risks of persistently weak inflation and an underperforming economy against the positive news of a reviving U.S. economy and a weaker Canadian currency, which should help exports.

Most economists think the report will emphasize economic disappointments, though not a single forecaster said a rate cut was in the cards.

"The Bank of Canada is poised to shift the tone and lean further toward a rate cut first, rather than go for an outright cut to start 2014," said Sebastien Lavoie, economist at Laurentian Bank, who forecasts a 50-point rate hike in the second quarter of 2015.

"The recent weaker trend in inflation implies that the (bank's) medium-term 2 percent target is less likely to be reached than before," he said.

In October, the bank projected inflation would return to its 2 percent target by the end of 2015, a forecast that now looks too optimistic. The annual inflation rate was 0.9 percent in November and has been below the bank's target for 19 months.

Business managers surveyed by the central bank late last year were confident inflation would remain within the bank's comfort zone of 1 to 3 percent, although over two-thirds of them expected it to be at the low end of that range.

Weaker Currency

The most striking development since the bank's last forecasts in October has been the rapid descent of the Canadian dollar against the greenback, a trend the bank will likely avoid mentioning explicitly, but which will influence its outlook.

The Canadian dollar has been on a downward trend since the bank's October rate announcement, when it unexpectedly abandoned its hawkish bias and shifted into neutral. The currency traded at a four-year low against the U.S. dollar on Wednesday.

A currency depreciation sometimes has a net monetary easing effect on the economy, taking pressure off the Bank of Canada to lower its rate. It is also a relief for exporters, giving them a sorely needed boost, and it normally also lifts inflation through higher import prices.

Derek Holt, economist at Scotia Capital who doesn't expect the bank to raise rates until the fourth quarter of 2015, said the bank typically estimates that a 10 percent depreciation of the currency lifts inflation by 0.3 percentage points over a two-year horizon.

But it's too early to say exactly what effects the exchange rate will have, he said, noting Bank of Canada Governor Stephen Poloz's warnings that the bank's models don't tell the whole story.

The bank may want more time to see how the foreign exchange market evolves, and to monitor the housing market through the busy spring season.

"At a minimum the bank's going to wait off until the summer months to evaluate all those four arguments: housing, exports, inflation and the dollar, and not act in an overly hasty fashion," Holt said.

"I think they will issue a very incrementally more dovish statement in terms of language and maybe a little bit more muted inflation profile," he said of next week's central bank statements.

Fed Tapering

There are arguments in favor of a rate hike this year: the pickup of economic activity in the United States and the U.S. Federal Reserve's decision to scale back its massive bond purchasing program, but the bank will be in no rush, said Mark Hopkins, economist at Moody's Analytics.

"Clear guidance by the Fed that it will maintain low rates - and the need to maintain the credibility of that forward guidance - will limit the upside risk on Canadian interest rate movements in 2014," he said.

The Reuters poll showed forecasters see a 78 percent likelihood there will be no change in the central bank's rate in 2014. They saw an equal 8 percent chance of either a rate cut or a hike this year.

Markets, on the other hand, are pricing in a reasonable chance of a rate cut later this year, according to yields on overnight index swaps.

Reporting by Louise Egan; Editing by Peter Galloway

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