Going into next Tuesday’s decision on interest rates, economists are split over what action the Bank of Canada will take. The market expecting a 25 basis point hike.

“The Bank of Canada has a real problem,” says BMO Nesbitt Burns. “Inflation is raging, but the economy has softened considerably, so what will they do next week?”

The consumer price index for January posted a 4.5% gain year over year. And, the core index was up 3.3%, well above the 2% midpoint of the Bank’s target band. But, growth in the fourth quarter gross domestic product came in at a disappointing 1.6% annual rate, which is by far the weakest reading in a year. “It must give the Bank pause, especially given the uncertainty surrounding the Iraq situation,” says Nesbitt.

“The latest inflation data scream ‘Hike’, while the latest growth figures shout ‘Hold’. Ultimately, the Bank’s job is to control inflation, so that is likely to carry the day next Tuesday,” says BMO. “But the markets suggest that there is still only a 50-50 chance that the Bank will raise rates. With so much uncertainty, they could well wimp out in the end. One thing is certain, the Bank will raise rates well before the Fed this cycle.”

TD Bank says that it also expects to see the Bank hike rates next week. Although, it allows that the Bank may have a hard time making the public relations case for a rate hike with growth looking so weak.

CIBC World Markets presents the case for the Bank to stay on the sidelines. “Clearly, inflation is now too high, even stripping out energy. It’s a dangerous game to continually excuse one special factor or another for higher prices and thereby fail to see the forest for the trees,” it allows.

But, CIBC says, “For price hikes to stick, buyers have to be able to pay them. Canadian workers are actually seeing their wage rates decelerate, with average hourly earnings running below a 2% pace. With energy bills for home heating pushing even higher in February, someone elsewhere in the economy is going to have to start offering discounts to find any buyers. If labour markets aren’t yet tight, then industrial markets are in comparison much slacker. Forget about Canada’s capacity use rates. Most of the goods we actually consume are bought on North American or global markets, where there is still an ocean of excess capacity.”

“All of that suggests that the Bank of Canada still has time on its side in the fight against inflation,” it says. “A sustained moderate pace of economic growth would bring inflation back down to earth as the energy price shock receded.”

“Just how sure can we be that today’s soft pace isn’t simply followed by more of the same?” CIBC asks. “And if so, there’s no need for a rate hike now.”