Central bankers in the developed world are going to be keeping interest rates low for longer as their economies struggle to regain their footing, predicts BMO Capital Markets in a new report.

In a research note, BMO suggests that central banks in the United States, Europe and Japan won’t be ready to raise rates any time soon, and those that have seen enough strength to start withdrawing monetary stimulus, such as Canada, will be pausing.

“There are two tenets to our [U.S. Federal Reserve] call. The first is that core disinflation is the Fed’s primary concern… The second is that, once inflation stabilizes and the risk of deflation lessens, the Fed is likely to begin tightening well before the economy has fully recovered from its ills,” it says; but it notes, “this second tenet is fast becoming a distant blip on our policy radar screen.”

Indeed, it suggests that, as the Fed will want to ensure that disinflation has definitely ended before beginning tightening, the earliest Fed rate hike will be in the third quarter of 2011.

“Furthermore, there is a small (albeit rising) risk that additional quantitative easing and unsterilized credit easing might be required to ensure that America steers clear of deflation, which would necessarily push any rate hike into 2012,” it adds.

For Canada, while BMO still expects the Bank of Canada to raise its policy rate 25 basis points to 0.75% on July 20, largely due to the “strength of domestic spending”, it then expects the Bank “to pause for at least a couple of announcement dates through the autumn.”

“By December, with U.S. deflation risk presumably ebbing, we could see the Bank resuming its rate hike campaign, with a cadence still dictated by developments outside Canada’s border. Even if the Bank opts to wait until the start of 2011 to resume, we look for this oscillating pattern of rate hikes and pauses to be repeated next year as the Bank steers policy on a cautious tact,” it says. “Once the Fed starts tightening, which would be a signal to the Bank that U.S. risks have receded sufficiently, Canadian rate hikes should become steadier.”

The risks elsewhere will also keep foreign central bankers wary of raising rates. “We’ve pushed our call for the first [European Central Bank] hike to the start of 2012, due to expectations of soft growth and low inflation,” it says. “In fact, considering the weak outlook, a strong case could be made for immediate further easing. However, it doesn’t appear that the ECB has any appetite for looser policy…”

It also expects the Bank of England to remain on the sidelines until 2012. And it says that the Bank of Japan “will keep its foot on the policy accelerator and rates shouldn’t move any higher through this year and next.”

IE