RBC Economics reports that polls of economists suggest that the majority believe that the Bank of Canada will lift the overnight rate by 25 basis points to 4.25% at this Wednesday’s policy rates meeting. It argues that the Bank will hold steady.

Market participants hold a different view from the economists, RBC notes. It reports that futures trading suggests that roughly 50% believe the Bank of Canada will keep rates unchanged. “Our forecast is for the Bank of Canada to leave rates unchanged at 4% until the fall. Since expectations are not unanimous, bond, money and foreign exchange markets are sure to jump on the Bank’s decision,” it says.

RBC explains that four reasons leading it to believe the Bank will hold steady. For one, upward revisions to labour productivity in 2005 from an initially reported 1.1% to 2.2% suggest that the neutral rate of growth of the economy could be higher than previously thought and, that the degree of excess demand in the Canadian economy is lower than projected in the Bank of Canada’s April Monetary Policy Report.

The possibility that the Canadian economy is not yet operating in a state of excess demand would imply lower inflationary pressures, it says. “Indeed, the April CPI report revealed that core CPI rose by only 1.6% after rising 1.7% in March, below the Bank of Canada’s forecast,” RBC adds. “The April core CPI reading adds credence to the possibility that the Canadian economy is not operating at full capacity.”

Also, while monthly GDP at basic prices points to real growth in the first quarter of roughly 3.5% – above the Bank’s forecast – RBC says other indicators point to lower growth because of the large drag coming through on net trade. Growth is expected to taper off in 2006 because of net trade and housing market weakness.

Finally, ex-oil commodity prices have fallen sharply over the last two weeks from their recent highs, but the Canadian dollar has fallen only 1.8% over the same period. “Hence, as Bank of Canada Governor Dodge recently mentioned, some degree of type-two movement in Canadian dollar valuation may be behind the latest divergence between fundamentals and the Canadian dollar valuation, further lessening the need for rate hikes.”