First Bank of Canada Rate Hike Since July 2007

June 1, 2010

Canadian monetary policy has been tightened as officials had hinted was their strong intention.  However, effort has been made to dampen concern that the central bank is now off to the policy normalizing races:

Given considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weigned carefully against domestic and global economic developments.

The following actions were announced:

  • The overnight rate target and the Bank Rate were each increased by 25 basis points to 0.50% and 0.75%, respectively.
  • The deposit rate was left at 0.25%, thus restoring the normal operating band of 50 basis points centered on the overnight rate target.
  • The target will be enforced by means of the standard operating framework in which Special Purchase and Resale Agreements (SPRA) and Sale and Repurchase Agreements (SRA) are utilized.
  • In three steps between now and June 16, excess reserves will be drained from CAD 3 billion currently to the typical CAD 25 million level of settlement balances for SPRA and SRA.

A statement explaining today’s actions said that considerable monetary stimulus remains in place.  Last month’s inflation forecast was endorsed, in which total on-year CPI is projected to hover between 2.3% and 2.4% over the coming four quarters before converging down on the 2.0% target from mid-2011 onward.  This overshoot will because by the harmonized sales tax.  Core inflation will remain slightly below 2.0% through the third quarter of 2011.  Because of Canada’s significant excess supply and uneven global recovery prospects, inflation would likely undershoot target in the medium term if monetary policy were not accommodative.

The statement is upbeat about Canadian growth, which officials last month projected at a G-7 best 3.7% this year, 3.1% in 2011 and 1.9% in 2012.  Officials today noted their hope for investment to accelerate while consumption decelerates.   So far, Europe’s problems have not exerted a big impact on Canada, such being limited to modestly lower commodity prices and somewhat tighter financial conditions.  But the statement candidly worries about possible renewed weakness in Europe and asserts that the “required rebalancing of global growth has not yet materialized.”

The last three major rate tightening cycles crested with the overnight rate target at 4.5% in July-December 2007, 5.75% in May 2000 – January 2001, and 8.0% in February-May 1995.  The world economy is in a different place now that will see lower cyclical peaks almost everywhere.  Today’s Canadian statement does not want markets to be speculating about another increase at the next policy statement date on July 20.  However, a rate target of 0.50% appears out of step with an economy that grew at a “robust” 6.2% annualized rate last quarter and which is projected to expand faster than 3.5% in 2010 as a whole. If the fall-out from the sovereign debt crisis cuts officials any slack, they’ll seize the opportunity to tighten again next month.  After all, there are only eight more scheduled policy meetings before mid-2011 by which time officials anticipate that Canada will be operating back at full capacity.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



Comments are closed.