Source: The Canadian Press

Canadian investors will look to the central bank’s interest rate decision for guidance this week, while U.S. markets are hoping earnings reports from a slew of major companies will help offset some abysmal economic data.

The Bank of Canada is expected to raise its key lending rate by a quarter percentage point Tuesday to 0.75%, another indication that Canada’s economic recovery has so far been stronger and faster than in the United States.

An interest rate hike by the Canadian central bank in a move to fight inflationary pressures in the economy could put some pressure on stock markets as they price in “greater odds of follow-up moves through October,” noted Avery Shenfeld, chief economist at CIBC World Markets.

News earlier this month that the Canadian economy created a whopping 93,200 new jobs in June, taking the country’s unemployment rate below 8% for the first time since the depths of the recession, “more or less put the lid on the question” of whether the central bank would hike interest rates, said Doug Porter, deputy chief economist at BMO Capital Markets.

“I wouldn’t say things are back to normal but they’re moving rapidly in that direction, at least in Canada,” Porter said.

“In that kind of environment, there is very little justification for extraordinarily low interest rates such as we still have in this country.”

Canadian businesses also helped pave the way for an interest rate hike in a key quarterly survey last week, indicating they were generally upbeat about the outlook for business activity over the coming year.

Half the firms surveyed by the Bank of Canada said they planned to add workers over the next 12 months, compared to only 10% that planned to cut their workforce.

Porter said he expects the central bank’s lending rate to reach 2.5% by the end of 2011. However, he added that he expects the central bank to continue using “very cautious language” for the time being.

While an interest rate hike and the Bank of Canada’s assessment of the economic recovery will impact investors, fallout from a slew of weak economic data in the U.S. will also weigh on markets this week.

Colin Cieszynski, market analyst at CMC Markets Canada, said Canada with its strong economy and low borrowing costs “is just about the only place where people are talking about raising interest rates.”

“Certainly in the U.S. they’re not, and in fact the Fed even said that if things slow down too much they’ll bring back more emergency measures.”

Major stock markets in Toronto and New York ended last week in the red following a much weaker-than-expected consumer confidence reading out of the U.S. on Friday, some uninspiring manufacturing data, soft retail sales numbers, a lower economic growth forecast from the Fed and a miserable jobs report for June.

Housing data out of the States this week could continue to pressure markets. Housing starts, due out on Tuesday, are projected to drop 5% for June, while existing home sales, which will be reported Thursday, are expected to fall 10% for the same month.

“I think we’re back to where we were about a year ago in terms of expectations for the recovery,” Porter said.

“Economists, analysts, the markets all have come to grips with the reality that we are coming back down to earth.”

However, the impact of weakening housing data could be mitigated if major companies slated to report earnings next week are able to impress, Cieszynski said.

“Right now you’ve still got a bit of fear out there, but if you do start to see large numbers of positive surprises pile up again, it should help to stabilize the markets,” he said.

Major U.S. companies scheduled to report second-quarter earnings this week include Delta Air Lines (NYSE:DAL), Texas Instruments (NYSE:TXN), PepsiCo (NYSE:PEP), Coca-Cola (NYSE:KO), American Express (NYSE:AXP), Amazon.com (Nasdaq:AMZN) and Schlumberger (NYSE:SLB).