July 13, 2011 / 1:09 PM / 6 years ago

Bank of Canada now seen raising rates in Q4

5 Min Read

<p>Bank of Canada Governor Mark Carney walks to a news conference in Ottawa April 13, 2011.Blair Gable</p>

TORONTO (Reuters) - The Bank of Canada will raise interest rates sometime in the fourth quarter as a sturdy, if unspectacular, domestic recovery offsets global headwinds, according to a Reuters survey.

The median forecast of a July Reuters poll of 37 economists and strategists pushed back previous rate hike forecasts of a third-quarter increase projected in a May poll.

The central bank is now seen holding its key policy rate at 1 percent in the third quarter.

Of those still expecting a third-quarter increase, all of them predicted a 25 basis point rise in September. None expect a hike next week at the central bank's July 19 rate decision.

The poll was conducted between July 8 and July 12.

While some recent Canadian economic data has been encouraging, it comes against a bleak global backdrop. Worries have spread about the euro zone debt crisis and there are signs of a stagnating recovery in the United States, Canada's largest trading partner.

U.S. job growth is a key focus, since its impact on U.S. consumer spending spills into the Canadian market.

"The soft patch that we obviously have in the U.S. right now we believe will prove temporary, that we'll get a little bit of a lift in the second half of the year," said Michael Gregory, senior economist with BMO Capital Markets.

"It does seem that Canadian growth continues to chug along, the output gap continues to close. If anything, I think the output gap may be even a little smaller than what the Bank of Canada is even estimating ... so that all points to the need to try and ratchet rates higher. They can't really wait until the Fed starts to go."

Canada was the first Group of Seven country to raise interest rates following the global financial crisis in 2008, lifting its target for the overnight rate three times last year before pausing.

Rate Seen at 1.50 Pct at End of q4

The median forecast also showed that the bank would end the fourth quarter with the key rate at 1.50 percent, down from 1.75 in the previous poll. The rate was seen ending 2012 at 2.50 percent, down from 3 percent.

Analysts said a rate increase would likely send the Canadian dollar -- already a point of concern for the central bank -- higher, which could result in another rate hike pause. The currency is currently above parity with the U.S. dollar, trading around $1.04.

The poll, which showed 16 of 37 forecasters expect the central bank to start raising rates in the fourth quarter, echoed the results of a poll of primary dealers conducted on June 29, which found most had pushed back their forecasts as well.

Two primary dealers -- the institutions that deal directly with the central bank as it carries out monetary policy -- have pushed their targets into 2012.

"It's a tough call, but our view is they're likely to wait until early next year and then gradually raise interest rates at that point," said Adrienne Warren, a senior economist at Bank of Nova Scotia.

"Certainly, the path will be contingent on the performance of the U.S. economy ... There's so much uncertainty out there in the economic outlook right now. Sentiment can change quite easily over the next few months in either direction."

In the current poll, five of 11 primary dealers surveyed expected the first rate hike to come in the third quarter, compared with 10 in May's poll. Four predicted a hike in the fourth quarter.

BMO Capital Markets pushed its expectations for the first increase to the fourth quarter from the third. Desjardins Securities was unavailable as it was currently revising its forecasts.

Overnight index swaps, which trade based on expectations for the key central bank policy rate, showed investors see only a slim chance of a rate hike this year.

One concern for the Bank of Canada is recent data that showed inflation rose to 3.7 percent in May, its highest level in more than eight years. That was well above expectations and far above the central bank's 2 percent target.

Citi, one of the forecasters, said it pushed back its expectations of a rate hike to October from July, despite the data.

"Despite the swell in May consumer prices, our change reflects the temporary lull in Canadian economic growth, as well as ongoing uncertainty surrounding the sovereign debt crisis in Greece, and upcoming debt ceiling and budget showdowns in the United States," Citi said.

($1=$0.96 Canadian)

With additional reporting by Sarmista Sen, Shaloo Shrivastava and Bangalore polling unit; editing by Jeffrey Hodgson and Rob Wilson

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