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Rate hike will be gradual

From the TMG Executive Vice President, Steve Whitehead;

Rate hike will be gradual

On Tuesday April 17, the Bank of Canada (BOC) left its key interest rate untouched – it has remained steady at 1% since 2010. However, the BOC’s Governor Mark Carney hinted at rate increases starting as early as this summer. If that happens, the cost for consumer loans, lines of credit and variable rate mortgages will increase. The key rate is the interest rate at which major financial institutions borrow and lend one-day funds among themselves.

Carney’s decision to increase rates will depend on a number of variables being played out right now. Last July, Carney sent a strong signal that higher rates were coming, only to reverse that stance in September.  His challenge now is to ensure inflation stays under control as the economy strengthens, but without dampening consumer spending and/or curtailing business investment that will be crucial to the country’s growth over the next couple of years.

The BOC clearly laid out its case for raising rates. The bank boosted its 2012 growth forecast for Canada to 2.4%, from 2 % in January. While it cut its 2013 forecast to 2.4 per cent from 2.8 per cent, policy makers said the economy will be back at full tilt in the first half of 2013, instead of in the third quarter of that year.

But a few days ago, Statistics Canada reported the inflation rate had dipped to 1.9% in March — the first time since September 2010 that the rate has fallen below the Bank of Canada’s target of 2%. And since Carney’s interest rate announcement, a few other factors have come into play.

The U.S. Federal Reserve Board is sticking with its near-zero rate until 2014, putting pressure on Canada to keep its current rate as is. The rebound in the United States, Canada’s chief export market, is not as robust as analysts would have liked suggesting the U.S economy is still vulnerable. Considering this is an election year, it’s likely to stay that way until the election is over.

The euro crisis is still making headlines, which is worrisome; and at the mere hint of an interest rate hike, the loonie shot up more than a full cent against the U.S. dollar, which is not good for many of our business sectors. In his April 17 announcement, Carney did say the “timing and degree” of interest rate moves would depend on developments in the coming weeks. Those developments are already here. And while he has hinted at a summer hike, well, without a crystal ball, it’s still too early to call.

One thing we can be sure of is that when the hikes do come, they will be gradual.