July 22nd, 2004

By Peter Diekmeyer o Bankrate.com

Last week's decision by the Bank of Canada to keep its key lending rate unchanged and to shift its stance toward a tightening bias, is giving Canadians more time to get used to coming hikes.

Many experts had expected the Bank to announce some monetary tightening in its Tuesday rate announcement decision, due to recent positive growth and inflation numbers. Instead the Bank, --citing little change in its outlook, --decided to maintain its target rate at 2%, where its has sat since Mid-April.

However Bank of Canada Governor David Dodge hinted that rates won't stay low for long.

"As economies approach their production capacity, monetary stimulus must be removed to avoid a buildup of inflation pressures," said Dodge, at a press conference on Thursday, to announce the release of the Bank's update to the April Monetary Policy Report.

"In Canada the timing and magnitude of interest rate increases will depend on evolving prospects for inflation and for pressures on capacity."

Beyond traditional geopolitical concerns, Dodge cited three factors that the bank would be watching: the size of the output gap (the difference between production and capacity), trade growth and the effect of oil prices on the Canadian economy.

According to recent data, it appears that the U.S. economy is slowing, but the Bank does not expect effects from that slowness to spillover into Canada. As a result the Bank lowered its U.S. GDP growth estimates to 4 1/2 percent in 2004 and 4 1/4 percent during 2005, but kept projections for the Canadian economy unchanged at 2 3/4 percent for 2004 and 3 1/2 percent for 2005.

The inflation picture also looks extremely positive for the coming months. The Bank is prediction that inflation, --one of the indicators it watches the most-- will within its 1% to 3% target range until the end of 2006.

Caught off-guard

According to one industry professional the Bank of Canada's inaction caught many by surprise.

"Lenders were anticipating an increase and their (lending) rates were firming up," said Pierre Fournier, president of Multi-Prêt Hypoteques, Quebec's largest mortage broker. "But after the (Bank of Canada's) announcement, two or three financial institutions made cuts, and now we are back to where we were before."

Most industry experts believe that rates have bottomed out and that now is the best time for consumers to borrow new money or to lock in mortgages for longer terms.

And according to Fournier, demand remains high. "It's not just here in Canada," said Fournier, in a quick phone interview just before leaving to visit Multi-Prêts new Paris offices. "It's the same everywhere."

According to another expert, the Bank's caution was to be expected.

"We weren't surprised by the announcement," said Carlos Leitao, chief economist for Laurentian Bank Securities. "The bank likes to give warning before it changes its policy. And by shifting its bias toward a tightening, it signaled that it is ready to move either in September, or more likely in October."

The bank's decision to hold back on rate hikes is good news for consumers who can borrow at historically-low levels. According to Bankrate.ca's regular survey, the average interest rate for a five-year closed mortgage sat at 6.1% on July 25th, 2004, and the variable open rate was at 3.72%.

Although the Bank of Canada's key rate is not directly tied to lending rates, there is a strong connection. And the Bank's decision it indicates that those low mortgage and borrowing rates could stay that way for a while yet.

The Bank's next rate announcement will be made on July 20th.

Previous Bank of Canada action:

Date Action Overnight rate (after announcement)

July 20, 2004 No change 2%
June 8, 2004 No change 2%
April 13, 2004 -1/4% 2%
March 2nd, 2004 -1/4% 2 1/4%
January 20th, 2004 -1/4% 2 1/2%
December 2nd, 2003 No change 2 3/4%
October 15th, 2003 No change 2 3/4%
September 3, 2003 - 1/4% 2 3/4%
July 15, 2003 - 1/4% 3%

Schedule of upcoming Bank of Canada rate announcements:

September 8th, 2004
October 19th, 2004
December 7th, 2004

peter@peterdiekmeyer.com

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