Super low interest rates may be coming to an end

But with economic conditions slowly showing signs of improvement, Carney may not be on hold until late 2013 as many had assumed.

Higher interest rates make it more expensive for households to borrow and could lead to a cooling of Canada’s housing market, although economists say they expect any monetary tightening from the central bank will be gradual.

The recent C.D. Howe Institute policy council report found three of nine economists surveyed believing the central bank should start preparing Canadians for higher rates, and raising the policy setting within the next 12 months. The majority still favoured staying put, however.

“As growth gets stronger and as we increasingly get closer to capacity, we start thinking interest rates have to get on the path towards normal and normal is much higher than one per cent,” said Royal Bank chief economist Craig Wright.

The argument for raising rates early next year — or in the case of some analysts, late this year — got stronger last week after Statistics Canada revised the third-quarter 2011 growth performance to a robust 4.2% from 3.5. Even though 1.8-per-cent growth in the fourth quarter was on consensus, December’s 0.4% monthly spurt set up the economy for a healthy start of 2012.

Scotiabank economist Derek Holt said the GDP revisions suggest the Canadian economy should get back to balance as many as three quarters earlier than the Bank of Canada’s forecast of the fall of 2013.

Wright adds another reason for optimism. Fiscal drag from government spending restraint likely won’t be as punitive to growth this year as it was in 2011, when the economy still managed a 2.5- per-cent advance.

That would normally suggest that the central bank should start raising rates about six-to-nine months earlier than it had previously planned to, although no-one knows what is in Carney’s or his policy-setting team’s mind.

While the reasoning has some backing, most analysts believe Carney is not as eager to move as his continued warnings about the dangers of low interest rates and high Canadian household debt would suggest.

The big problem is that his U.S. counterpart, Federal Reserve chairman Ben Bernanke, has yet to rule out further easing south of the border, and forecast interest rate tightening won’t happen until 2014.

Any hike in Canada would exacerbate the spread between the two North American central banks, and put upward pressure on the loonie, which is currently trading at par.

“If Carney comes out and hikes 100 basis points in the next year, we could be dealing with a Canadian dollar at $1.10 US, and you can bet manufacturers and exporters will be howling on Parliament Hill if that happens,” said Holt.

A strong loonie makes shipments of goods to the U.S. market more expensive, leading to lower levels of exports and declining economic production in Canada.

CIBC’s Benjamin Tal says the argument against raising rates be even stronger in 2013 because that’s the year the U.S. government will likely be forced into austerity, which will depress the economy.

For Bank of Montreal’s Douglas Porter, who is also on the C.D. Howe panel, concern about the Canadian dollar may be the key to Carney’s actions.

He said he expects Thursday’s statement from the central bank will express more confidence in Europe and global risks than at the last meeting in January, but “I expect they’ll hold their fire,” he added.

“The bank simply cannot be that far ahead of the Fed without causing mischief for the Canadian dollar,” he said. “They’ll never put it that way, but the reality is it’s tough for them to move aggressively independently of the Fed.”