Canadian interest rates are going higher, although the timing remains uncertain, TD Bank says.

In a report issued Tuesday, the TD defends the Bank of Canada’s stance on rates, noting the central bank raised rates by 25 basis points on March 4 and has signaled that more tightening in monetary policy is in the cards. “While a conflict in the Middle East may keep policy on hold at the April and June rate pronouncements, there is every indication that the overnight target rate will be increased further by yearend,” says the report by senior economist Craig Alexander.

TD says that the Bank’s position has been criticized because there are signs that Canadian economic growth has slowed, rate increases will raise debt service costs, and widening spreads between Canada and the U.S. are fuelling an appreciation in the Canadian dollar that will cripple Canada1s export sector. “In our opinion, these views overstate the potential fallout from the recent and likely future tightening in monetary policy,” Alexander says.

TD argues that, even with the weaker growth in the fourth quarter of 2002, the Canadian economy is still operating at close to full capacity, so two more quarters of sub-par growth will open up only a small output gap. In addition, much of the weakness in the U.S. economy is due to uncertainty over a potential war in Iraq. “By the second half of this year, we expect the uncertainty to have lifted, setting the stage for a rebound in Canadian and U.S. economic growth to 4%, or better. As a result, what little slack there is will be taken up quickly, leaving the Canadian economy operating at close to full capacity once again.

“Given this outlook, and with core inflation currently running above the Bank’s 1%-to-3% target band, the central bank was fully justified in raising rates last week, and we anticipate a further 100 basis points of tightening by year-end,” Alexander says. “The message is that while monetary policy will continue to support economic growth, the Bank will be pressing less hard on the accelerator by the end of the year.”

TD says that it believes that the interest payments on personal debt will increase only modestly as a result of the Bank’s decision to reduce the degree of monetary stimulus. “Indeed, despite the prevailing record debt levels, the current interest payments as a share of disposable income are running at their lowest level in a decade. Thus, even allowing for the Bank’s expected tightening in monetary policy, the modestly higher interest payments should remain manageable for the vast majority of Canadians and does not pose a major risk to consumer spending.”

It also suggests that the appreciation of the Canadian dollar on commodity exporters will be reduced by a rising trend in commodity prices. “The main point is that the timing of the recent appreciation in the currency is regrettable, but Canadian exporters can cope reasonably well with the stronger currency once the U.S. economy is on the mend.”