As expected, the Bank of Canada raised interest rates 25 basis points this morning, bringing the target overnight rate to 2.50%. Economists are anticipating much more rate action in the months ahead.

The central bank’s accompanying policy statement “clearly sets the stage for more rate hikes at each of the remaining four meetings this year with at least two now expected to be of 50 basis points, pushing the overnight rate up 150 basis points to 4.00% by year-end,” say the economists of RBC Financial.

Given the rapidly diminishing slack in the Canadian economy, say TD Bank economists, the Bank of Canada must tighten policy by roughly 200 basis points before the monetary stimulus in the economy is eliminated. “Most importantly, the Bank also sent a strong signal that rates would continue to rise in the months ahead. It dropped any
references to uncertainties about the continuing strength in household spending and the timing of the recovery in business investment.”

With a strong outlook for the economy as well as the considerable lag between rate changes and their impact on economic activity, says TD, the central bank should shift monetary conditions towards a neutral setting in short order.

CIBC World Markets says that the interest rate market has already fully priced in another 25 bps rate hike that is anticipated to come out of the next Bank meeting. “The most recent easing cycle lasted a full year from January 2001 to January 2002, resulting in cuts of 375 bps. We expect the Bank to take back some, but not all, of those rate cuts in this current tightening cycle. Our CIBC forecast is calling for 100 bps.”

BMO Nesbitt Burns also suggests that it would take another 200 bps of tightening to get interest rates close to neutral. “Since the Bank first raised rates in mid-April, long-term yields have drifted lower, while 10-year Canada/U.S. spreads have been almost unchanged,” it says. “However, the loonie is up 4% since that time, providing some added tightening.”