When the Bank of Canada raised the target overnight interest rate a quarter point to 3.25% earlier this week, monetary policy in Canada continued to diverge from the actions taken by other central banks globally.

In a new report Standard & Poor’s notes with the latest increase the overnight rate is now 200 basis points above the U.S. federal funds target — the widest spread in eight years.

S&P says it expects this divergence to continue as Canadian monetary conditions remain highly expansionary as real short-term interest rates are still close to zero, albeit no longer negative.

“The bank is likely to continue reducing the amount of monetary stimulus at a gradual and measured pace. At this time, a more disruptive transition to less expansionary, or more neutral monetary conditions is unwarranted,” it predicts. “The likelihood is low that, in future, the bank would increase rates in larger 50 bps increments.”

With the war in Iraq winding down, S&P says lower energy prices in the coming months will help bring headline inflation in Canada (currently 4.6%) back within the bank’s target band, subduing inflation.

S&P notes that the bank has scaled back its expectations for GDP growth in 2003 based on the more sluggish start to the year, it says. The bank continues to expect below-potential GDP growth in the first half of 2003 without a meaningful pickup until late in the second half. “Such a scenario argues in favor of the bank staying with a tempered approach toward further rate increases and if growth in the U.S. economy continues to be sub par, the bank would even have reason to put its tightening program on hiatus again as it did in the second half of 2002. For now, the balance of risks skew in flavor of another 25 bps increase in the target overnight interest rate at the June 3, policy announcement.”