August 31, 2012 / 7:43 PM / 5 years ago

Markets to eye Bank of Canada tightening language

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 market will again look beyond the Bank of Canada's expected decision on September 5 to keep its main policy rate at 1 percent, and instead focus on whether Governor Mark Carney will change the message that the central bank may need to hike rates.

The fact that Carney repeated the tightening language as recently as a speech on August 22, just two weeks before the coming announcement, suggests he may leave the formula unchanged.

"To the extent that the economic expansion in Canada continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate," Carney said in the speech.

He used those exact words in the central bank's decisions on June 5 and July 17, and while he acknowledged on August 22 that recent data has been soft, he also said the underlying momentum was roughly in line with the growth of the economy's potential.

Second quarter growth came in on Friday exactly as the central bank had forecast in July, at an annualized 1.8 percent and higher than markets expected, though a good portion was attributable to a less-than-helpful increase in inventories.

The fact the data was in line with the central bank forecast provides "exactly zero reason for the Bank to shift from its mild tightening bias," Benjamin Reitzes, senior economist with Bank of Montreal, wrote in a note to clients.

A Reuters survey of 40 forecasters showed none expect a rate change on September 5. The median prediction is for a rate hike in the second quarter of next year.<CA/POLL>

Currently, the central bank is the only one in the Group of Seven (G7) leading industrialized countries with a tightening bias, which it has maintained in the face of a dreary economic and financial picture in Europe and elsewhere.

Canada is leading the G7 in growth -- indeed three G7 members currently either have zero or negative growth.

The Bank of Canada was the first in the G7 to raise rates after the last recession, though it has kept them at the still unusually low level of 1 percent since September 2010.

Yields on overnight index swaps, which trade based on expectations for the Bank of Canada's overnight rate, had long shown investors expecting a cut despite the central bank language and despite economists' expectations of an eventual hike.

However, for the most part the swaps now predict the next move to be up, with at least a 50 percent chance of a hike by September 2013.

A CIBC World Markets study on Aug 28 said it expected fiscal retrenchment by federal and provincial governments might well keep growth at a mediocre level that "could handcuff the Bank of Canada in 2013."

Editing by Jeffrey Hodgson

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