As the market expected, the Bank of Canada left the overnight rate unchanged at 1% on Thursday, and offered a more hawkish tone in its accompanying comments on the economy, however that doesn’t mean higher rates are imminent.
“While today’s statement provided no reason to alter our call, the risks that the Bank will tighten sooner are rising,” says RBC Economics, which is expecting the Bank’s next move will be an interest rate increase in early 2013.
The risk of an earlier tightening comes as the outlook for the economy brightens, and some of the looming downside risks recede. BofA Merrill Lynch notes that, in Thursday’s statement, the Bank expressed less concern about the euro sovereign debt crisis, and acknowledged signs that economic conditions in the U.S. and Canada are improving. Also, inflation was noted as above expectations, and that there was less spare capacity than thought due to the upward revisions to 2011 GDP.
“Sometimes it is more important to look at what the Bank did not say in the statement,” Merrill notes. “Most notably, the Bank today dropped the comment about symmetric upside and downside risks to the outlook and no characterization of risks was provided. In our view this omission suggests a leaning to upside risks to inflation.”
Nevertheless, Merrill says that it still expects that the next move from the Bank will be a cut. It thinks the recent strength in the economic data “will not last”, and that other issues will re-emerge. “The Eurozone sovereign crisis is not contained and the U.S. faces a massive fiscal shock in 2013 that will become a more pressing concern for risk-takers by this summer,” it says.
“Moreover, mild winter weather is likely providing a significant boost to GDP currently and that boost will turn to a drag as normal weather patterns re-emerge,” it says. It reports that in previous mild winters, growth usually runs about 2.5% higher than normal through the winter and then downshifts by a similar amount in the spring and summer months.
While Merrill is still expecting a further cut, most economists expects the Bank’s next move with be a hike. TD Economics says that today’s announcement reinforces its view that “while rates will remain low in Canada, they will very likely rise in mid-2013 or perhaps earlier, compared to the likely move by the Fed in 2014.”
National Bank Financial also expects the Bank to resume rate hikes by mid-2013. “That said, the budgets season is likely to influence the Bank’s decision making process,” it says. “The extent of the fiscal drag coming from the federal and provincial budgets (especially Ontario and Quebec) remain unknown at this point. The expected gradual reduction in monetary stimulus over time will have to be paced accordingly.”