Canadian economists see more interest rate hikes ahead for both sides of the Canada-U.S. border.

Bank of Montreal notes that U.S. Federal Reserve Board chairman Alan Greenspan “remained upbeat on the economy’s prospects” in Congressional testimony yesterday, and offered no hint that the Fed is nearing the end of its tightening cycle.

BMO reports that Greenspan noted that the economy “appears to retain important forward momentum.” A lingering concern is that high energy costs could spill over into general prices, implying that further rate increases are needed to keep inflation in check, it adds.

“The chairman’s comments support our view that the Fed will extend the tightening cycle at the next two policy meetings on December 13 and February 1. This will bring the fed funds rate up from 4% currently to a more neutral level of 4.5%,” it says. “A dominant risk, however, is that rates could climb even higher, at least temporarily, to keep inflation pressures at bay.”

TD Bank economists agree, saying in a new report, “Any hopes that the Fed may be on the verge of winding down its tightening run are rapidly dissipating. And, the perception that the Bank of Canada is in the midst of a cautious stop-and-go approach to monetary tightening is being dented as well.”

It suggests that the negative fallout from hurricane Katrina is proving to be much less severe than initially feared, and the Canadian economy appears to be adjusting to the stronger Canadian dollar. “Both economies are operating at or close to their capacity limits – and consequently, high energy costs are not the only reason the central banks have to keep their sights on the inflation ball,” it says.

It predicts that the Fed will keep on tightening until the Fed funds rate hits 4.50%, and “increasingly, there is a risk that it could go beyond that point.”

“And, with the Bank of Canada’s overnight rate at only 3.00%, there is still 100 basis points to go on this side of the border,” it suggests.

“Yet, it is clear that both central banks are still ahead of the inflation curve. As long as they continue tightening in order to pre-emptively quash inflation in the bud, inflation should be relatively well-contained, and therefore supportive of the long end of the yield curve. And, that is the textbook curve flattening story,” TD concludes.