Expectations of a Bank of Canada rate cut have largely evaporated from the market, says research firm Global Insight Inc. Instead, higher inflation points to the risk of a rate hike somewhere down the road.

“Recent inflation and employment data suggest the balance of risks for Canada’s monetary policy is slowly moving towards a rate hike from a rate cut,” the firm says in a research note. “This balance has swung several times since last May, while the Bank of Canada kept the overnight rate steady at 4.25%.”

The recent data present the Bank of Canada with a quandary, Global Insight says. GDP has been growing at a pace below potential since a year ago — 2.5% is expected in the first quarter compared with the potential rate of about 2.7% — but there are tentative signs of unwelcome inflationary pressure. “If future CPI reports show heightened inflation, then the bank would likely increase its estimate of excess demand at the end of 2006,” it predicts, adding that the expected path of excess demand will be critical in judging whether a rate hike is justified in the near term.

“Financial markets have largely priced out formerly prevalent expectations of the Bank of Canada rate cut from government T-bills. For market sentiment to shift decisively towards a rate hike, the Bank of Canada would have to indicate that inflationary risks have moved from balanced to higher,” it says. “The press release following the April 24 monetary policy announcement date and the April 26 Monetary Policy Report will both be read very closely for such signals.”

Global Insight says it expects the bank to continue to stay on the sidelines in coming months. “We do anticipate the overnight rate to increase to 4.50%, but such a move will wait for at least sometime next year after the U.S. and global economies fully regain their footing following this year’s slowdown.”