There’s slightly better than even chance of a rate hike by the Bank of Canada next week, as it weighs the strength in the domestic economy against substantial downside risks on the global stage, says TD Economics.

In a research note TD says that after the central bank’s last rate decision, the market had thought that a June 1 rate hike was practically a lock. “But circumstances have changed since then, and the market is now back to that same level of trepidation and uncertainty as before the April 20th rate decision,” it says.

“Arguing in favour of a rate hike, the level of the overnight rate is astonishingly low, and domestic economic conditions are undeniably strong. Arguing against is the potential repercussions from the European fiscal crisis,” TD observes. “Although our conviction has wavered at times, we continue to believe that the Bank of Canada is more likely to hike the overnight rate on June 1st than not.”

Over the medium term, TD says that the range of possible economic and central bank outcomes has broadened considerably, and its confidence about any one scenario is reduced. Its base case assumes steady removal of monetary stimulus in Canada, with the expectation that the overnight rate will be around 1.50% at the end of 2010, and potentially north of 3.00% at the end of 2011.

“But the risk to this view is that the BoC could be somewhat more cautious in its actions than we assume, with a non-trivial chance that the BoC could reach some intermediate level and opt to pause for a period of time until the economic outlook solidifies,” it cautions.

IE