No one expects the Bank of Canada to raise rates on Tuesday, says TD Bank Financial Group. However, the Bank of Canada may have to do so soon in order to deal with the bigger and more pressing issue of Canada’s weak productivity performance, TD says.

Of 20 dealers surveyed by Bloomberg LP, none expect the Bank of Canada to change its key policy interest rate tomorrow, TD reports, and almost all predict the Bank will remain on hold through September. TD says that it sees things differently. “We are alone in calling for a 25 basis point hike in July and another in September, which would take the rate to 4.75%,” it says.

“The reasons for this off-consensus position cut to the heart of the monetary policy challenge. Weak productivity growth means that the Canadian economy cannot expand strongly without compromising the Bank’s 2% inflation target,” TD argues. “Consequently, the Bank of Canada must tighten the dial on monetary conditions. The recent rise in the Canadian dollar is doing some of the lifting, but in good part this is a reflection of strength in the Canadian economy, particularly through high commodity prices. Higher interest rates will also be required to cool inflation pressures.”

TD says that it is now clear that GDP growth in the first quarter was stronger than 3%, “and the hand-off to the second quarter suggests that the Bank’s growth expectation will once again be exceeded.” Indeed, TD estimates that the Bank of Canada’s main measure of capacity pressure will show significant excess demand at the end of the second quarter.

Also, TD points out that the core rate of CPI inflation is running at 2.5%, which is half a point above the Bank’s target. And, it says that the inflation pressure is pervasive. “The condition of excess demand and a breached inflation target is reality. To be sure, monetary policy must be forward looking. But if the current pace of inflation gets embedded in inflation expectations it will be hard to eradicate. The Bank of Canada has earned a high degree of credibility for meeting its target. That credibility would be eroded if it allowed inflation to exceed its target for a lengthy period without responding,” TD suggests.

Apart from forecasting rates, TD observes that, “something is very wrong with this economic picture”. Namely, “The Bank of Canada is saying that based on its assessment of trend productivity growth, the Canadian economy cannot grow faster than 2.8% per annum without compromising the inflation target. In the near term growth must be even weaker to remove the excess demand. Worse, we expect the Bank of Canada to again revise down the estimated speed limit for the economy because Canada’s actual productivity performance has been falling short of their estimate of trend growth for quite some time. The result may well cap growth in the economy to 2.5% per annum or possibly even lower.”

That said, TD allows that there’s not much the Bank of Canada can do to bolster Canada’s pathetic productivity performance “other than maintaining low, stable inflation”.

“Other agents of the economy, in the public and private sectors, need to mount a concerted effort to turn around the situation. For years we have been hearing dire warnings that as the baby boomers retire Canada will slip into a lower growth path. Sadly, we’re there now,” it says.

“Nobody may be expecting the Bank of Canada to raise its interest rate tomorrow. But they would be justified in doing so. And if they don’t act tomorrow, they will need to soon. Many actors in the economy will understandably be upset. If the angst could be directed at efforts to mount a concerted, national effort to drive up productivity growth every Canadian would be better off,” TD concludes.