October 18, 2012 / 6:51 PM / 6 years ago

Bank of Canada not seen tightening until fourth-quarter 2013

OTTAWA (Reuters) - The Bank of Canada will postpone interest rate hikes until the fourth quarter of next year and will likely water down rather than eliminate its hawkish language when it announces its next rate decision on October 23, a Reuters poll of market forecasters showed on Thursday.

In defiance of the global trend of easier monetary policy, Canada’s central bank has signaled since April that it is looking at raising borrowing costs. But market expectations on the timing of such a move have been pushed back repeatedly by the sputtering global economy.

The Reuters poll of the 42 forecasters showed none expect a change on Tuesday in the central bank’s main policy rate, now at 1 percent. The median prediction is for a first quarter-point rate increase in the fourth quarter of 2013, two quarters later than was forecast in an August 28 poll.

“There’s a feeling that there’s not a lot of flexibility here,” said Mark Hopkins, senior economist at Moody’s Analytics.

“The fourth quarter for rate hikes is splitting the difference between when they would probably want to start raising rates given economic conditions and the constraint that they can’t get too far ahead of the Fed,” he said.

Canada’s 12 primary dealers, the banks that deal directly with the central bank as it carries out monetary policy, also forecast a fourth-quarter 2013 hike, the poll showed.

Central bank Governor Mark Carney is in a difficult spot. Rate hikes would go a long way to solving the headache of soaring household debt and a hot housing market.

But if he moves too far in advance of the U.S. Federal Reserve, he risks driving up an already strong Canadian dollar, which would hurt the export-reliant economy.

Despite their closely interwoven economies, there is a dramatic disconnect between Canadian and U.S. housing markets.

Canadian property prices lagged U.S. gains heading into the financial crisis, then soared to dizzying heights in cities like Toronto and Vancouver as buyers took advantage of the record low borrowing costs that followed the recession.

Now, as the battered U.S. housing sector is finally showing signs of a recovery, Canadian sales are dropping and some fear a U.S.-style collapse.

Finance Minister Jim Flaherty said on Thursday he may have to downgrade his outlook for the economy in a fiscal update due this Fall. Ottawa bases its fiscal projections on the average growth forecasts of a group of private sector economists.


The Reuters poll was taken after a speech by Carney on Monday divided and confused many central bank watchers.

On the one hand, some analysts declared him more dovish because he said the bank’s revised economic outlook would factor in the impact of heightened global uncertainty.

He also dropped a reference, made just two weeks earlier by his deputy Tiff Macklem, that gradual rate hikes “may become appropriate,” language the bank has repeated since the spring.

Carney said instead the bank would take “whatever action is appropriate” to meet its inflation target.

But some analysts thought the central bank was simply opting to exclude specific language on policy because it was so close to the rate announcement.

Only one third of the poll respondents thought the bank would abandon its tightening bias completely next week.

But a majority - 21 of the 36 who answered this question - expect it to soften its hawkish language, while still tilting towards eventual tightening.

“The bias will be modified to more clearly reflect its long-term nature,” said Benjamin Reitzes, economist at BMO Capital Markets.

A group of economists at the C.D. Howe Institute, a think tank, recommended on Thursday the central bank hold rates through April 2013 but said it now urges slower and more moderate increases in the rate than they had in August.


Carney could deal with his conundrum by getting innovative in the Monetary Policy Report on Wednesday. Instead of providing the usual “base case” projections, he may lay out several scenarios for growth and inflation, depending on what happens in Europe, the United States and Asia.

He may have hinted at this in his speech when he said: “... we can be transparent about what we expect and how we would react to different scenarios.”

Sebastien Lavoie, an economist with Laurentian Bank, is betting Carney will take this route.

“What the markets will realize is that most of these scenarios implicitly include interest rate hikes down the road,” Lavoie said. “I think the main motivation of the bank, perhaps, is that they don’t want market participants to price in rate cuts, these mythical rate cuts,” he said.

Markets have been pricing in a small chance of rate cuts this year instead of hikes, according to yields on overnight index swaps, which trade based on expectations for the policy rate. Bets on rate cuts have typically spiked when fears about Europe’s debt crisis have been at their worst.

Carney’s interest in transparency could also lead him to go a step further and follow in the footsteps of U.S. Federal Reserve Chairman Ben Bernanke by providing more transparent guidance on the future path of interest rates.

In Canada’s case, this would likely mean making clear to markets that the bias is toward rate hikes in the medium term even if the timeline for doing so may shift back and forth due to events in the rest of the world.

Polling and additional reporting by Shaloo Shrivastava and Ashrith Doddi in Bangalore; Editing by Jeffrey Hodgson and Peter Galloway

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