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Canadian interest rates are on their way up

Until last week, most Canadian economist (institutional) took the view that, in their opinion, Canada should raise interest rates, but that the BoC appear to look for any excuse not to raise them. It had become a joke; last month it was America forthcoming recession, and this month it would be "Club Med's possible default", well, how a BoC rate setting meeting can change things.

Canada's impressive Q1/11 growth (granted a good chunk of that was inventory growth) at 3.9% (annualized) far exceeds the BoC's anticipated growth rate of 2%, the "transitory" inflation story is proving to be not so transitory, as headline CPI remains at 3.3% while core is around 1.6% -- both figures are considered high!

Yesterday's BoC statement (keeping overnight rates steady) signaled that this policy is about to change, giving Canadian interest rates analysts a "good feeling" that by the end of 2011, the BoC overnight rate could be as high as 2%... Ideally this would lead to a whole shift upward of the Canadian interest rate curve (maybe). In its statement the BoC indicated that current interest rates were excessively stimulative for an economy that appears to be operating at capacity (hence the signs of inflation), and that it was time for the BoC to "normalize" interest rates!

The market is now pricing the probability of a rate rise on Q3, at around 25% (probability of a 25bps increase), but since the market is slow to react to such "ideas" it may take a while until this trend is reaffirmed by the futures market. BTW, and this is important, the BoC doesn't like to to surprise the market, expectation for inflation (CPI) is for 2.3% for the whole year -- right in the middle of the target range for the BoC -- Economists have a tendency to be more aggressive than the market for interest rate increases -- C.D. Howe Institute has been calling for rate rise for nearly a year now...

Addendum: This comment now seems out of date, the street is now only thinking of a Q1/12 25 bps rate rise... the action south of the border and in Europe make any tightening suicidal

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