Bank of Canada expected to stand pat

The Bank of Canada is scheduled to hand down a decision on interest rates on September 6. Many economists are predicting the bank will again forego a rate hike, in response to slower economic growth in the second quarter.

“Growth in the second quarter came in well below the Bank of Canada’s expectation for a 3.2% increase,” said David Tulk, an economist at TD Economics. “Despite the fact that core inflation is running at the 2% target, the bank is likely to focus its attention to the effect that the slowing in the U.S. economy will have on Canadian economic growth.”

On Thursday, StatsCan reported that real GDP rose by just 2% in Q2, missing the consensus estimate of 2.3%. That marks a sharp decline from Q1 growth of 3.6%, which was itself revised from an initial report of 3.8%.

While economic growth is slowing, inflation is expected to finally show its head in the labour market, with reports from Morneau Sobeco and Watson Wyatt predicting average wage increases of between 3.4% and 3.5% in 2007.

Not only does Tulk expect the Bank to stand pat in September, but he says it is increasingly unlikely that rates will change before year-end. Rishi Sohdhi, an economist at RBC Financial, agrees.

“The [GDP] report is consistent with no change in interest rates at next week’s Bank of Canada meeting and tilts the risk towards no more hikes for the remainder of the year,” says Sondhi.

Such a move — or, more accurately, an absence of movement — is precisely what the C.D. Howe Institute’s monetary policy council is calling for. In a release issued on Thursday, the council recommended the Bank maintain its key overnight interest rate at 4.25%.

But this recommendation was far from unanimous. Of the 12 members on the panel, only six advocated no change, while five members believed the economy could withstand another 25-basis-point rate hike. One member, Carleton University economics professor Nicholas Rowe, suggested the bank cut rates by 25 basis points to 4%.

“Members favouring a more aggressive stance by the bank tended to highlight concerns about inflation and inflation expectations running above the 2% target and the need for rapid action to bring expectations back to 2%,” the council said in its release. “Members content with an unchanged target, and the one member advocating a decrease, tended to highlight signs that economic activity at home and abroad is slackening and that the overnight rate is likely already at, or very close to, the level consistent with 2% inflation.”

Looking further out, the council recommended the bank increase rates to 4.5% at its October 17 meeting. Seven of the 12 members recommended this 25-basis-point hike, while three suggested maintaining the rate at 4.25%. Michael Parkin, professor of economics at University of Western Ontario, recommended rate hikes for both meetings, making him the only member to advocate a 4.75% overnight rate for the October meeting. Rowe maintained his 4% target.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com