Analysis: Canada rates seen lower for longer; cuts unlikely

Wed Aug 10, 2011 3:02pm EDT
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By Ka Yan Ng

TORONTO (Reuters) - A dovish U.S. Federal Reserve will likely force the Bank of Canada to keep its interest rates lower for longer, but market bets on a Canadian rate cut by year-end are unlikely to pay off.

Analysts said a rate cut would send all the wrong signals for an economy that is growing, albeit slowly, and could hurt the central bank's credibility.

"In the current situation, a rate cut by the Bank of Canada would mean that you have a second recession in Canada," said , Charles St-Arnaud, Canadian economist and currency strategist at Nomura Securities International in New York.

"And that's not something that we see happening."

Expectations for Canadian interest rates have swung wildly in recent weeks. As recently as July 19 traders priced in higher expectations of a rate increase this year, following unexpectedly hawkish language from the Bank of Canada.

A July 20 survey of primary dealers showed most saw a rate hike in September or October.

But tightening expectations fell sharply as the U.S. debt ceiling debate and the downgrading of the U.S. credit rating by Standard & Poor's fueled fears of a recession there, triggering some of the worst stock market selloffs since the collapse of Lehman Brothers in 2008.

Canadian overnight index swaps, which trade based on expectations for the Bank of Canada's key policy rate, and short-dated government debt began to show expectations of a rate cut rather than an increase.   Continued...

<p>Bank of Canada Governor Mark Carney walks from his office to a news conference upon the release of the Monetary Policy Report in Ottawa July 20, 2011. REUTERS/Chris Wattie</p>