The Bank of Canada today announced that it is maintaining its target for the overnight rate at 4.25%. The operating band for the overnight rate is unchanged, and the Bank Rate remains at 4.5%.

The Canadian dollar jumped above the US93¢ level after the central bank signalled that inflation pressures may lead to higher interest rates sooner rather than later.

In its statement accompanying today’s rate announcement, the Bank of Canada said that inflation and economic growth are now running ahead of projections released in April.

The core inflation rate — which excludes volatile items such as gasoline, and fresh fruit and vegetables — surged to a four-year high of 2.5% last month.

“On balance, the bank judges that there is an increased risk that future inflation will persist above the two% inflation target and that some increase in the target for the overnight rate may be required in the near term to bring inflation back to the target,” the bank said.

The result of that statement was a quick spike in the Canadian dollar on foreign exchange markets. The loonie was up 0.71 of a cent at US93.28¢ –a new 30-year high.

Bay Street economists agree that rate hikes are coming soon.

RBC Capital notes that the Bank moved to a more hawkish outlook for inflation and indicated that “on balance, the Bank judges that there is an increased risk that future inflation will persist above the 2% inflation target and that some increase in the target for the overnight rate may be required in the near term to bring inflation back to the target.”

The Bank also highlighted that “there is somewhat greater excess demand in the economy than was thought to be the case in April”, and that the Canadian dollar is stronger than the Bank expected.

“With Canada’s economy running at a strong pace (RBC forecasts that GDP grew at a 3.5% annualized pace in the first quarter) and the core inflation rate riding at 2.5%, the Bank of Canada had little choice but to add a more hawkish tone to today’s press release,” it said. “This firmer tone suggests to us that the Bank will raise the policy rate at its next fixed action date in July. It also likely means that we will see more than one rate hike in 2007.”

Indeed, RBC has changed its call on the timing of rate increases and now expects the Bank to raise the policy rate by 75 basis points in 2007 and by an additional 25 bps in 2008, a cumulative tightening of 100 bps. Its previous call was for a 25 bps rate increase in late 2007 and an additional 75 bps of increases in 2008.

TD Bank agrees that the Bank has clearly shifted in favour of an imminent rate hike. “This statement blows open the door to what we believe will be the first of two 25 basis point increases in the overnight rate starting at the Bank’s next Fixed Announcement Date on July 10th. This action will bring the Bank’s key lending rate to 4.75% by the end of the year,” it said.

BMO Capital Markets is a bit more cautious than some of the other banks, although it allows that, “Today’s statement represents a significant shift in the Bank of Canada’s view.” It also says that the Bank’s “overtly hawkish message substantially raises the risks of rate hikes”, but it also says this new stance “puts the onus on the data to prevent the Bank from raising rates.”

“There is only one CPI report between now and the July 10 meeting, and it will be crucial. There will also be a pair of employment and monthly GDP reports prior to that meeting, which could also be decisive,” BMO says. Despite highlighting the role that coming data will play, BMO is onside expecting hikes sooner rather than later, saying, “The main point now though is that Bank tightening is almost entirely a question of when, not if, and we believe that “when” could now be as early as July.”

National Bank Financial points out that Canadian inflationary pressures are building at a time when they are fading south of the border. “Since we are clearly heading to CAN-US short rates convergence over the next nine to 12 months, the probability of seeing the loonie approaching the parity level before Governor Dodge leaves office is on the rise,” NBF says. “While he reacted strongly against such bold prediction a year ago by mentioning that analysts and economists tend to exaggerate from time to time, the loonie strength could become again a hot topic on parliament hill if the Bank acts unilaterally in coming months. The probability of such an outcome has increased from 40% to 75% now.”

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An updated analysis of the bank’s outlook for growth and inflation, including economic and financial developments, trends, and risks, will be set out in the MPR update, to be published on July 12.

The next scheduled date for announcing the overnight rate target is July 10.