April 13, 2012 / 6:33 PM / in 5 years

Bank of Canada to hold rates, may up forecasts

OTTAWA (Reuters) - The Bank of Canada looks set to not touch interest rates on Tuesday but will likely keep with the more hawkish tone it has adopted in the past month and may even add an explicit mention of eventual rate increases.

The central bank has frozen its overnight lending target at an extremely low 1 percent for 19 months and is seen standing pat until the second quarter of 2013, according to the median forecast in a Reuters poll of 40 analysts. <CA/POLL>

Domestic economic growth and inflation have come in a bit stronger than the bank had predicted at the start of the year, so it is widely expected to raise those forecasts slightly in its quarterly Monetary Policy Report on Wednesday.

That raises the potential for earlier monetary tightening as the bank would normally seek to bring rates to more neutral levels as the economy returns to full capacity, to avoid inflationary pressures.

“A lot of the factors would normally imply potentially tightening, or less stimulus needed in the system. We’re not expecting any imminent move, but consistent with it they could put in a comment that at some point the current amount of stimulus will need to be withdrawn,” said Paul Ferley, assistant chief economist at Royal Bank of Canada.

Since recovering from the 2008-09 recession, the Canadian economy has trudged ahead at a moderate pace. Bank of Canada Governor Mark Carney raised rates from their crisis low of 0.25 percent in mid 2010 but has not seen fit to do more since because of anxiety over the European debt crisis and the sluggish U.S. performance.

Those fears are dissipating, analysts say, but have not vanished entirely.

Meanwhile, Carney has increasingly turned his attention to a homegrown risk - excessive household debt related largely to mortgages.

“Domestic housing prices and household balance sheets are a clear risk for the Bank. We expect the statement to shift to a more hawkish stance, which will be positive for the Canadian dollar,” Scotia Capital currency strategists Camilla Sutton and Eric Theoret said in a note to clients.

In an April 2 speech, Carney painted a less frightening picture of the threats from abroad but warned that high household debt levels were “unsustainable”.

He also said any revisions to the growth and inflation outlook in the MPR would reflect fiscal restraint measures announced in the recent federal and provincial budgets. Ottawa announced it would cut nearly 6 percent of departmental spending, resulting in the loss of 19,200 jobs over three years, although overall spending will continue to rise.

The overnight index swap market, which trades based on expectations for the bank’s main policy rate, showed traders see almost no chance of a rate hike this month but have priced in a very small chance of one later this year.

Editing by Jeffrey Hodgson

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