Central bank seen hiking interest rates

(September 2, 2005) The Bank of Canada should raise its key overnight lending rate 25 basis points to 2.75% next week, says the C.D. Howe Institute’s Monetary Policy Council. And bank economists seem to support the call.

Nine of the 10 panel members voted for the increase. “The group felt that, notwithstanding weakness in some sectors, there is little or no slack in the Canadian economy at present, and that the time is right for the Bank of Canada to move the overnight rate toward the level that is compatible with steady growth and stable inflation over the long term,” C.D. Howe said in a statement.

Six of the 10 council members also felt that interest rates should be bumped another quarter point in October to 3%.

Bank economists appear to share the council’s view. “The lack of spare capacity, a policy rate that currently remains accommodative and the risk of surging energy prices entering into core inflation suggest that the bank has no choice but to move rates higher,” says RBC’s Jack Homareau.

“We believe the bank will not stop after one or two hikes but will continue through a series of measured hikes until the overnight rate reaches a level deemed neutral, likely around 4%,” he adds.

“The Bank of Canada and the U.S. Federal Reserve Board may still raise interest rates,” says CIBC World Markets chief strategist Jeffrey Rubin. “But the bond market is already viewing that as a monetary policy error, given the forecast implied by falling long rates, and with oil trading at near $70 per barrel, who can blame it?”

The C.D. Howe council also debated the impact of Hurricane Katrina on the Canadian economy. While some emphasized the negative effects of the damage, especially to energy production, others argued that its positive implications for Canadian exports were more important.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com