August 12, 2011 / 1:57 PM / in 7 years

Canadian banks shift rate hike views into 2012

TORONTO (Reuters) - Canada’s biggest banks have pushed their rate hike forecasts into next year following some of the worst financial market turmoil since 2008.

Only last month, most had called for the Bank of Canada to resume tightening this fall. But on Friday, RBC Capital Markets, BMO Capital Markets, and CIBC World Markets, all Canadian primary dealers, confirmed they now see the central bank’s key rate unchanged at 1 percent until 2012.

They join TD Securities and Scotia Capital, who were early movers on seeing rate increases holding off until in 2012, based on the deteriorating global economic and fiscal conditions. Other forecasters have also indicated their economic outlooks are under review.

“We just think that, given the fact that inflation has receded, and the disappointing U.S. recovery and the fact that this financial market turmoil will likely hit growth temporarily, we just don’t see the bank moving this year,” said Doug Porter, deputy chief economist at BMO Capital Markets.

Just three weeks ago, traders were pricing in higher odds of a rate increase this year, following unexpectedly hawkish language from the Bank of Canada.

A July 20 survey of primary dealers, institutions that deal directly with the central bank as it carries out monetary policy, showed most saw a rate increase in September or October.

The swings in the market, mixed economic data, and the twin debt crises in Europe and the United States were all factors behind changing forecasts.

“But if the U.S. eschews a disastrously sharp fiscal tightening, Canadian growth will be sufficient to nudge overnight rates higher,” said Avery Shenfeld, chief economist at CIBC.

He sees a 25-basis-point rate increase in each of the first two quarters of 2012, “but nothing more than that over the balance of the year as Canada’s own fiscal tightening provides enough additional braking force.”

Some forecasters were already leaning toward delayed rate hikes, but cemented their views after the U.S. Federal Reserve pledged on Tuesday to keep interest rates low for at least another two years.

Traders of Canadian overnight index swaps, which are based on expectations for the Bank of Canada’s main policy rate, have been more aggressive in their view of where the economy might be headed.

Swaps markets had fully priced in a 25 basis point rate cut later this year on mounting fears of a global slowdown. But the odds have now been pared back in recent sessions as stock markets rebounded.

While more economists now expect Canadian interest rates to stay lower for longer, few expect an outright cut. They warn this would send all the wrong signals for an economy that is growing, albeit slowly, and could hurt the central bank’s credibility.

“I don’t think the market pricing is wildly unreasonable. There is a far outside risk that the bank could cut in a real emergency, whereas it’s very tough to see them raising rates,” said Porter, who expects interest rates to rise three times next year, once per quarter, starting in the second.

RBC Capital Markets said late on Thursday in a report that, based on current conditions, the priced-in rate cuts appear “wholly unjustified.”

“While the underlying domestic growth picture is little changed since the BoC initiated (and strengthened) its tightening bias — the prospective growth path has changed dramatically,” RBC said in the report.

“The bank also laid out a pretty clear criteria for acting upon this bias — a containment of the sovereign debt crisis, continued strong business investment and supportive net exports — these pre-conditions are far from being met at present and are unlikely to be in place before mid-2012.”

Editing by Jeffrey Hodgson and Rob Wilson

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