July 10th, 2007


Blurb: The bond markets had predicted a series of central bank rate hikes. However after today’s increase, future moves are in doubt.


Was the BoC rate hike a sign of things to come?


By Peter Diekmeyer • Bankrate.com


After a more than a year-long pause, the Bank of Canada returned to tightening mode this week, by raising its policy rate 25 basis points to 4 1/2 percent.  The central bank’s move, widely expected in economic circles, was made primarily to stem the persistent inflation generated by the strong economy of recent months. The question is whether the recent increase will be followed by others.


In fact until recently many economists had been expecting a series of central bank rate hikes. That’s because interest rate increases tend to come in spurts. For example the last time that the Bank of Canada returned to tightening mode was in September 2004. At that time the central bank’s 25 basis point policy rate hike sparked a series of nine increases during the next 20 months.


However according to one expert, this time around, future increases are less certain. “The tone in the Bank of Canada’s press release (announcing today’s decision) was far more nuanced than markets had expected,” said Warren Lovely, a senior economist at CIBC World Markets. “Prior to today’s rate hike, the bond markets had been pricing in a series of increases down the road. However the bank’s outlook was not hawkish as some had feared.”


Strong wage gains spark inflation fears

Unlike the US economy, which has been burdened by a weak residential real estate sector, the Canadian economy has been going great guns. Rising commodity prices, particularly for oil, are good news for Canada which is rich in them. Gains there, which are reflected in the sky-rocketing loonie, have more than made up for a weak manufacturing sector.


Job creation as a whole in Canada has been particularly impressive. Close to 35,000 new positions were created in June alone. And as if that was not enough, another 27,000 part-time jobs were replaced by full-time positions during the month.


However according to one expert, strong job creation is creating a risk of resurging inflation. “There are clear signs that continue to point to a tight labor market,” said Sébastien Lavoie, an economist with Laurentian Bank Securities. “Put simply, there are very few people looking for jobs, but a lot more jobs looking for people. To attract workers, firms have no choice but to increase remuneration.” In fact average hourly earnings rose by 3.2 percent in June, far above the central bank’s 2 percent inflation target.


Housing market shows continued strength

Any mention of interest rate hikes gets stakeholders in Canada’s residential real estate sector shifting in their seats. Mortgage rates, which have been relatively low on a historical basis in recent years, have been a key driver of the housing market activity, a trend that has continued through 2007.


For example home sales activity in major markets as measured by the Canadian Real Estate Association’s Multiple Listing Service rose by 11.0 percent year-over-year to a record 60,735 units in May. And led by strength in Western Canada, particularly Alberta, the average selling price of those homes rose by a stunning 10.8 percent year-over-year in May to $314,258. New housing starts are also showing continued strength so far this year, though they slipped slightly in June to a seasonally adjusted rate of 225,500 units.


The good news is that although several of Canada’s largest banks quickly raised their prime rates following the Bank of Canada’s move, it is far from clear that mortgage rates will rise as well. In fact mortgage rates are more closely tied to long-term bond yields which actually began to slip slightly after the central bank’s announcement due to growing uncertainty about whether future policy rate increases are on the way and if so how many.


What does this mean for the future?

Among those who are taking a cautious wait and see attitude are the CIBC’s Warren Lovely, who believes that although another rate hike is likely in the cards, the Bank of Canada could just as easily take a pass on further action.  


“The central bank has left itself a fair degree of maneuver room in its most recent statement. That’s in part to due to the strong loonie which is making Canadian exports less competitive on international markets,” said Lovely. “To the extent that the strong currency acts to cool the Canadian economy, you could say that it is doing the work that higher interest rates would normally do.”



Recent Bank of Canada rate moves:


July 10, 2007, +1/4%, 4.5%

May 29, 2007, No change

April 24, 2007, No change

March 6, 2007, No change

January 16, 2007, No change

December 5, 2006, No change

October 17, No change

Sept. 6, No change

July 11, 2006, No change

May 24, 2006, +1/4%, 4 1/4% 

April 25, 2006, +1/4%, 4.0%

March 7th, 2006, + 1/4%, 3 3/4%

January 24, 2006, + 1/4%, 3 1/2%

December 6, 2005 + 1/4%, 3 1/4%

October 18, 2005 + 1/4%, 3.0%

Sept. 7, 2005 + 1/4%, 2 3/4%

October 19, 2004 +1/4% 2 1/2%

September 8, 2004 +1/4% 2 1/4%
April 13, 2004 -1/4% 2%


The Bank of Canada’s rate announcement schedule:

September 5, 2007
October 16. 2007
December 4, 2007




Peter Diekmeyer (www.peterdiekmeyer.com) a freelance business and economics writer.






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