Friday’s inflation report from Statistics Canada has set the stage for this week’s interest rate announcement from the Bank of Canada.
Indeed, all eyes will be on the bank and the text accompanying its report on Tuesday when the rate is set. Most economists expect there will be no change from the current 2%, but there is a growing chorus that the central bank will begin hiking rates at its next setting in September.
Many feel the economic environment has changed significantly since the bank snipped rates only three months ago. For one thing, rates have tightened in the U.S., employment has rebounded, business sentiment has revived, the housing market is on the verge of overheating, and inflation has bottomed.
“In this environment, near-zero real interest rates are simply not appropriate – even when fiscal policy was extraordinarily tight in the late-1990s, real rates were generally well above 2%,” say Douglas Porter and David Watt, senior economists with BMO Nesbitt Burns Inc.
“The persistence of such low real interest rates combined with robust global growth and a red-hot housing market pose a meaningful threat to stable inflation,” they say in a new report. “The Bank has long maintained that core CPI inflation will stay below 2% until late 2005, but this sanguine forecast is at serious risk. Core inflation averaged 1.7% in Q2, above the Bank’s April call of 1.4% and also already above the 1.6% outlook for the second half of 2004.”
Warren Lovely, senior economist, with CIBC World Markets, also expects the bank’s target rate to hold at 2% next week, but he says don’t be surprised by a quarter-point jump come September.
Lovely also notes that inflation is running faster than the Bank has projected. “In this environment, the threat of higher rates to come will be hard to miss. And just as they have begun to climb stateside, rates will need to go higher in Canada,” he says in a report.
Lovely says the Bank was previously too optimistic on growth, especially when it comes to the U.S. expansion, where evidence of moderating growth has mounted.
“Beyond any initial tightening, however, what the Bank says and what they eventually deliver could prove to be very different things. It’s not today’s rate of inflation, but inflation 12 or even 18 months down the road that they attempt to dictate. And just where is the North American economy likely to stand as 2005 draws to a close? Not on quite as elevated a terrain as they had foreseen, unfortunately.”
Other releases this week in Canada include international security transactions for the month of May due out on Monday, the June leading indicator on Tuesday, and the Bank of Canada policy report update on Thursday.
In the U.S., it will be a relatively quiet week. Of note will be housing starts on Tuesday. Economists say there could be a rush on new houses in anticipation of higher mortgage rates ahead, which could mean a solid pace of starts in June.
Also due is the June leading indicator, out on Thursday.