Bank of Canada raises rates to 4%

For the sixth consecutive time, the Bank of Canada has raised the overnight lending rate 25 basis points, to 4%, hinting more increases may be needed.

“Some modest further increase in the policy interest rate may be required to keep aggregate supply and demand in balance and inflation on target over the medium term,” the Bank of Canada said in a release. “The bank will closely monitor evolving developments in the Canadian economy in light of the cumulative increase in the policy interest rate since last September.”

The big banks immediately followed the central bank’s lead, raising prime rates to 5.75%.

In its reasons for the latest increase, the Bank of Canada said the economy is judged to be operating at, or just above, its production capacity. High energy prices are expected to kept total CPI inflation slightly above the bank’s target 2% target, but core inflation is still below 2% due to downward pressure from prices of imported goods.

The central bank is also paying close attention to global competition and the soaring loonie, which continue to test a number of sectors in the economy.

The economy is projected to grow by 3.1% this year, 3% in 2007 and 2.9% in 2008. According to the bank, total CPI inflation is projected to average close to 2% in 2007 and 2008, which doesn’t account for the effect of any changes the Conservative’s may make to the GST. “The bank judges that the risks to its projection are roughly balanced, with a small tilt to the downside later in the projection period,” it said in a release.

Overall, the bank appears to sending mixed signals, experts say. TD economist Craig Alexander says the outlook for interest rates in the future is “clear as mud.”

“Today’s communiqué suggests that bank may be still leaning towards hiking rates again, but it is also signalling that it will be extremely reactive to forthcoming economic data,” he adds. Alexander says TD is sticking with its view that the bank is done raising rates.

“The language of the press release was more hawkish than expected, keeping the door wide open for further rate increases if the data allow,” says BMO Nesbitt Burns deputy chief economist Douglas Porter. “We view 4% as the very low end for neutral, and expect at least one more rate hike this cycle, possibly at the next decision date.

The next interest rate announcement is scheduled for May 24. A recent survey of Canadian economists and academics indicated a split between staying the course or continuing to raise rates.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(04/25/06)