As expected, the Bank of Canada today raised its key overnight rate for the first time in over a year to 4.5%, from 4.25%.

The move was widely anticipated as the Canadian economy has been growing rapidly. Inflation is now at 2.2%, slightly higher than the 2% target that Bank of Canada aims to achieve.

It was the first rate hike by the bank since May 2006.

Canada’s banks quickly moved to raise their lending rates. RBC Royal Bank increased its prime lending rate by 25 basis points to 6.25% from 6%.

Bay Street economists see more rate hikes on the horizon, but they are divided over the unexpectedly cautious tone of the Bank’s statement.

RBC Capital Markets says that the central bank “indicated that further rate increases would likely be needed in the “medium term” to move inflation back down towards its 2% mid-point inflation target”.

The tightening in large part reflected the fact that inflation is coming in higher than expected, RBC noted, adding that the Bank is now forecasting that core inflation will not return to the 2% mid-point until early 2009. It previously projected hitting this rate by the end of 2007. “Higher inflation is the result of the economy operating further above its production capacity,” it says.

“The Bank of Canada is making clear that, with the economy currently in excess demand, further tightening will be required to get inflation back down to its 2% target. Although the Bank is conceding that the risks to inflation are more balanced, this is in relation to a higher inflation projection. As well, to achieve this eventual moderation, they are making clear that further, albeit modest, rate increases will be required,” it says.

RBC is sticking with its prediction that another 25 basis-point hike will likely be necessary in September followed by another similar-sized move before the end of the year. One final rate increase is expected early in 2008, bringing the overnight rate to a near-term peak of 5.25%, it added.

However, several other firms say the Bank may be more reluctant to hike. National Bank Financial suggests that the surging loonie could temper the need for rate hikes. It says that the odds that only modest hiking is necessary are “substantial”. But it still expects the Bank to hike at its September 5 meeting. “Obviously, should the Canadian dollar already be significantly above 95¢ by Labour Day, we think that our central bank would need to reconsider what its next move should be.”

TD Bank also stresses that, “while the Bank has left the door open to another move in September, the accompanying statement was more even-handed then many had anticipated, thus pouring cold water on any expectations that the central bank is entertaining a long string of hikes.” It sees an additional 25 basis points boost at the next meeting in September, but nothing more.

This call is echoed by BMO Nesbitt Burns, which says, “While the Bank is likely to hike again in September, they seem to be sending a fairly clear message that they don’t foresee a sustained tightening campaign, partly because the strong Canadian dollar is doing some of the work for them. The Statement’s relatively mild tone may also be aimed at avoiding a further spike in the currency.”

The central bank’s next rate announcement is scheduled for September 5.