OTTAWA — The Bank of Canada kept its trend-setting overnight interest rate steady at 1 per cent but warned that higher borrowing costs are on the way.
If the economy continues to improve, a gradual increase in the central bank’s key rate may lead to an uptick in the interest rates commercial banks charge consumer and business borrowers, central bank governor Mark Carney said Tuesday.
“Some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the (Bank’s) 2-per cent inflation target over the medium term,” he said in a statement accompanying the rate-setting announcement.
Higher interest rates tend to draw in foreign capital, in turn bolstering the Canadian dollar, so the Bank’s hawkish hints touched off an upsurge in the loonie’s value. It closed on exchange markets at 100.99 (U.S.) cents, up .96 of a cent from Monday.
The central bank raises interest rates to slow economic activity and thus dampen inflation, and this was Carney’s strongest warning about a possible rate hike since last summer. However, the move toward increased borrowing costs in July 2011 never materialized because of the eurozone crisis. And this time the central bank was vague about timing.
Economists doubt the upward move will come before late 2012 or early 2013.
“We anticipate that, despite the change in language in (the Bank’s) announcement, rates will remain lower than normal for some time,” TD Bank economist Diana Petramala said. “The language of the communiqué makes a rate hike by the end of 2012 highly likely, but the timing is still uncertain.”
Carney has kept the central bank’s trend-setting rate at 1 per cent since September 2010 because of lacklustre economic conditions.
But Canadians’ high level of household debt, a development in part driven by the central bank’s low-interest-rate policy, remains “the biggest domestic risk” to the economy, Carney said. He has repeatedly warned the Bank’s inflation-fighting mandate will require it to raise Canadians’ borrowing costs as soon as possible.
The central bank said the Canadian economy is picking up speed but could be slowed by high oil prices.
The “headwinds” from overseas that have been holding back Canada’s economy have somewhat abated as the U.S. recovery has shown some staying power, Carney pointed out.
And he said Canada’s growth this year would hit 2.4 per cent, a significant improvement over the 2-per cent growth for 2012 predicted only a few months ago.
Despite the more upbeat outlook, the Bank expressed concerns about the possible negative impact of high energy prices. It said improved global economic prospects, supply disruptions and geopolitical risk have kept commodity prices elevated.
“If sustained, high oil price developments could dampen the improvement in economic momentum,” Carney said.
Analysts say Carney remains in a bind. If the Bank raises rates to fight inflation, it is likely to drive up the value of the loonie on exchange markets, which makes Canadian exports less competitive and thus undercuts economic growth at home. This predicament has led to speculation that the central bank governor has in the meantime turned to trying to shock the public into thinking twice about loading up on more debt.
Higher interests rates are not inevitable in the near future given the still-fragile nature of the recovery, notes CIBC World Markets chief economist Avery Shenfeld. “We’re going to walk the line on whether those interest rate hikes are needed in terms of growth rates this year,” he commented.
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Les Whittington | The Toronto Star
