Following today’s widely anticipated move by the Bank of Canada to raise the overnight rate by 25 basis points to 3.00%, most Canadian economists are girding for more hikes to interest rates.

However, there’s less consensus on how high rates will go, and how fast.

According to economists at Royal Bank, the Bank of Canada, in its statement accompanying the rate announcement, indicated that the Canadian economy is now operating at full productive capacity compared to the September statement that said the economy was operating close to full capacity.

The central expects the economy to operate near full capacity through 2007 and predicts that core inflation will reach the mid-point of its inflation target band by the middle of 2006, RBC reports.

“The Bank clearly states that further increases to the overnight rate are coming in order to ensure that inflation remains well behaved,” RBC says. “This hawkish stance by the Bank does not surprise us. The steady improvement in the trade numbers combined with a strong domestic economy suggested to us that the economy was likely producing at its full productive capacity.”

RBC says the policy statement supports its view of another rate hike in December so that the overnight rate ends the year at 3.25%. “We believe more hikes are coming until the overnight reaches 4.00% by the middle of next year and remain at that level through the remainder of 2006,” it adds. “We will get a better understanding of the Bank’s views on economic growth and inflation prospects this Thursday with the release of its Monetary Policy Report.”

Bank of Montreal points out that the Bank of Canada sees the risks to the near-term outlook as balanced, though it perceives a downside risk to global growth in 2007 and beyond. “This likely reflects concern that the large US current account deficit could lead to a destabilizing plunge in the greenback, higher U.S. interest rates and a weaker U.S. economy,” it suggests.

“The Bank’s comments support our view that the overnight rate target will continue to climb steadily in the months ahead,” BMO concludes. “We see quarter-point rate hikes at each of the next four successive fixed announcement dates to April. Two additional moves later in 2006 will bring rates up to a more neutral level of 4.5% by the fall of that year.”

National Bank Financial agrees that more rate hikes are planned, although it notes, “ as the Bank and the Fed move monetary policy close to neutral, both central banks’ actions will become more and more sensitive to incoming economic data.”

“Today’s statement ups the odds that the Bank of Canada will be back again with a 25 bp ‘Christmas present’ in December. A December hike will be conditioned on maintaining 3% real GDP growth in Q4 and on seeing no significant turn in the fortunes of the Canadian dollar and the U.S. dollar globally,” comments CIBC World Markets.

NBF suggests that the downside risks will materialize earlier than the Bank of Canada assumes. “In particular, 2006 could see a significant slowing down of U.S. consumer spending. If, as we expect, North American economic statistics show less vigour in 2006, the Bank of Canada is likely to be pushed to the sidelines in the first half of the new year,” it predicts.

TD Bank reads the statement as saying “Although there is some distance upward left to go, the peak level of interest rates will likely occur next year, and what’s more, rates may have to decline marginally somewhere down the road to absorb the fallout from an unwinding of global imbalances.” TD Economics says its forecast is consistent with this view, calling for the overnight rate to reach 4.00% by mid-2006, before beginning a gradual downward slide thereafter.”

CIBC reports that fixed income markets sold off temporarily in light of the Bank’s explicit call for further rate hikes, but, “The impact faded in further trading as the market digested the Bank’s cautious tone on 2007, and as the scope for a reaction was limited by the fact that the yield curve had already priced in a December hike prior to today’s announcement.”