OTTAWA (Reuters) - The Bank of Canada laid the groundwork on Thursday to raise interest rates from current record lows, saying it was time to start withdrawing some of the stimulus that helped pull Canada out of recession.
Reinforcing a message it delivered earlier this week, the central bank said it was no longer promising to keep its key rate at 0.25 percent until the end of this quarter.
It forecast growth of 3.7 percent this year, and said core inflation, which strips out one-off factors, was set to stay close to its 2 percent target.
“With recent improvements in the economic outlook...it is appropriate to begin to lessen the degree of monetary stimulus,” it said in a low-key Monetary Policy Report that paves the way for Canada to become the first big industrialized nation to raise rates since the recession started.
“The extent and timing of any additional withdrawal of monetary stimulus will depend on the outlook for economic activity and inflation, and will be consistent with achieving the 2 percent inflation target,” it added.
The report added details to a statement the bank made on Tuesday in which it left rates unchanged but made clear that higher rates were coming.
Before that statement few had forecast the bank would raise rates at its next rate-setting date on June 1. But a Reuters poll conducted on Tuesday showed 11 of Canada’s 12 primary dealers now expect a June rate hike of 25 basis points.
Yields on overnight index swaps, which trade based on expectations for the Bank of Canada’s key policy rate, edged lower after Thursday’s report, showing the market saw rate hikes in 2010 as a touch less likely than it did before the report.
The Canadian dollar rose as high as C$0.9990 per U.S. dollar, or $1.0010, from C$1.0014 per U.S. dollar before the report.
At news conference, Bank of Canada Governor Mark Carney declined to be drawn on the timing of a rate hike. “Next question,” he said tersely.
Thursday’s central bank forecasts assume an average exchange rate of 99 U.S. cents per Canadian dollar, matching the average of the last month. But a strong dollar is one of a raft of factors that could upset the bank’s forecasts, by slowing growth or making Canadian firms less competitive.
“There are still a fair number of key things that they are worried about,” said Sheryl King, chief economist at Banc of America-Merrill Lynch.
“The immediate implications for the Canadian dollar are neutral to slightly negative right now because the market has gotten slightly excited and probably a little bit over-anticipatory about very aggressive rate increases, and I don’t think these headlines validate that.”
The central bank said risks to its forecasts were roughly balanced. Stronger growth could boost demand for Canadian exports and add to inflation, while a higher Canadian dollar and poor productivity could slow growth and dampen inflation.
It said global imbalances could “pose significant risks to the outlook” and insisted that advanced economies like the United States need to rein in deficits, while other countries must boost demand and allow exchange rate adjustments.
Carney, who will attend top level international talks in Washington this weekend, said talks about a global tax on banks to cover the costs of any future financial crisis are a “distraction” from core issues such as bank capitalization and liquidity.
The bank expects the private sector to become the sole driver of domestic demand in Canada by 2011, making this year a “turning point” as monetary and fiscal stimulus, which kick-started the recovery, are withdrawn.
Finance Minister Jim Flaherty, already in Washington for the Group of 20 talks, said he was “relatively comfortable” with the Bank of Canada’s projections, saying they show Canada is emerging from the recession stronger than any other G7 country.
The central bank said the housing sector, marked by fierce bidding wars in Toronto and Vancouver, had exceeded its expectations, but that activity in the sector should weaken later this year.
Additional reporting by David Ljunggren, Claire Sibonney, Jennifer Kwan, Euan Rocha and Louise Egan; editing by Peter Galloway