Bank of Canada Raises Interest Rate But Changes Light to Amber from Green

July 20, 2010

In follow-up to a first 25-basis point rate increase on June 1, Canada’s overnight rate target was lifted by another 25 basis points to 0.75%.  The move was widely forecast, and analysts were most interested in any clues about future policy.  In several ways, today’s new Bank of Canada statement backpedals, suggesting a third rate increase at the next policy statement on September 8 is far from guaranteed and in fact more unlikely than likely.  The light on future rate guidance is no longer green but rather amber.

The previous June 1 statement had declared that “the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus.  The extent and timing will depend on the outlook for economic activity and inflation, and be consistent with achieving the 2% inflation target.”  While today’s message indicates that “considerable monetary stimulus” remains in place, it concludes that “given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.”

Projected Canadian GDP growth in 2011 was revised downward to 2.9% from a forecast 3.1% made in April and 3.5% predicted six months ago.  Bank of Canada officials also revised downward forecast growth in 2010 to 3.5% from 3.7%.  As a result, the monetary authorities now do not expect Canada’s return to full capacity until 4Q11 instead of 2Q11 predicted in their April Monetary Policy Report.  That means that policy neutrality need not be restored until six months later than thought previously.

The June 1 statement called the global economy “uneven.”  Today’s statement is even more guarded in characterizing the global recovery as “not yet self-sustaining.”  Plans for European fiscal restraint not only hurt regional growth prospects but are also “expected to slow the global recovery over the projection horizon.  “In the United States, private demand is picking up but remains uneven.”

Canada’s own recovery is being “led by government and consumer spending.”  A spike in housing is now reversing.  Some of the strength in consumption was borrowed from the future, and investment has been impeded by “global uncertainties.”  Core and total CPI inflation are still expected to hover near 2% throughout the forecast period.  Temporary distortions caused by provincial indirect tax changes will be disregarded by monetary officials.

In 2007-09, the Bank of Canada’s target interest rate was reduced by a total of 425 basis points in two distinct sequences.  The first 150 basis points from 4.5% to 3.0% was engineered in four moves from December 2007 to April 2008.  A six-month pause then occurred during a commodity price-led climb of inflation.  When the world recession intensified, two cuts in October 2008 totaled 75 basis points and were followed by reductions of 75 bps in December 2008, 50 bps in January 2009, 50 bps in March 2009, and 25 bps in April 2009.  The current target of 0.75% remains 125 basis points below the previous cyclical low of 2.0% from April to September 2004.

This Thursday, a new quarterly Monetary Policy Report gets published, which will flesh out the latest thinking of central bank officials in greater detail.

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



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