A Bank of Canada interest rate hike on Sept. 7 is certain, TD Bank economists say, given Canada’s robust economic backdrop and the Bank of Canada’s own signals, but the Bank may signal a pause in the accompanying policy statement.

A rate hike next Wednesday is a given, TD said, because the July Monetary Policy Report, released two days after the last rate decision, indicated the Bank would have to hike rates soon. “And, the rationale on that front is solid,” TD said. “The economy is operating at full capacity, and it has firmed up enough to be able to gradually absorb higher rates.”

The real question, TD said, is what the central bank will do from that point on. “Up to now, our call has been that the Bank will tighten policy at every meeting this year, the rationale being that it has every reason to go down the same road as the [U.S. Federal Reserve Board] — a sequence of 25 [basis point] moves until the overnight rate is closer to neutral.” However, the economists said, with the impact of Hurricane Katrina on gasoline prices, the U.S. economy and the Canadian dollar, the risks are mounting that the Bank of Canada will take a pause at the subsequent [rate decision meeting] in October.

The bank said this does not imply the tightening cycle is over. “But given the uncertainty, the central bank may well decide to temporarily sit back to assess the situation. In that context, the post-meeting statement becomes much more important than the decision itself,” it said.

“We think it will be difficult for the Bank to ignore the risks associated with the impact of Hurricane Katrina,” TD said. “The combination of the direct hit on the affected region and the jump in both gasoline and natural gas prices is likely to take a solid bite out of U.S. growth in the second half of the year. The Canadian dollar is heading toward the US85¢ level.

The bank said the domestic side of the Canadian economy will not be spared the pinch from higher gasoline prices. The central bank may decide a temporary pause is warranted to get a better handle on the way those risks may play out. TD said a pause would not be a problem as core inflation remains very well contained and monthly GDP growth came in at a modest 0.2% in June.

It concluded that, “the odds favour a rather dovish statement from the Bank of Canada — one that is likely to focus rather tightly on the risks from higher gasoline prices, slower U.S. growth, and a stronger Canadian dollar. The implication is that the BoC’s decisions would once again become heavily data-dependent, with much of the focus being on the Canadian dollar and the performance of the U.S. economy.”

TD said if there is a pause in interest rate hikes, it would not signal the abrupt end to the Bank of Canada’s tightening cycle. “On the contrary, we still expect the Bank to take a page from the Fed’s book, and proceed with steady, gradual rate hikes until policy eventually reaches more neutral levels,” it said. “And, in that regard, fixed-income markets remain much too sanguine in their expectations for Bank of Canada policy, especially in light of the rally of the past few days.”