Steady as she goes for Bank of Canada on rates, but big decisions lie ahead

The Canadian Press ~ The News
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OTTAWA - Bank of Canada governor Mark Carney has some tough decisions to make as the economy gains momentum, and one of the toughest may involve a magician's trick of misdirection.

The bank governor gets his first opportunity to comment on the state of the economy Tuesday when the central bank issues its scheduled announcement on interest rates.

Economists rarely agree on anything, but it would be difficult to find one in Canada that does not expect Carney to keep the bank's trendsetting interest rate at the lowest practical level of 0.25 per cent for another cycle.

As well, the C.D. Howe monetary policy panel is unanimous in saying Carney will also stick to his "conditional commitment" to keep the rate at the so-called lower bound for another six months.

It's what comes next and what Carney says about that now which may require focusing the audience's eyes away from what is really happening.

The C.D. Howe panel of 10 economists is recommending that Carney raise interest rates as soon as his commitment expires - in July - with a majority saying the rise should be 50 basis points to 0.75 per cent.

The problem is that the U.S. Federal Reserve is now believed set on keeping interest rates south of the border at zero until the end of the year, and any prior move by the Bank of Canada will light a fire under the loonie. And that's the last thing Carney wants to happen, says independent economist Dale Orr.

"The bank does not want markets to think it will move before the Fed because that drives up the dollar and that could nip off recovery," he explains.

"So what I expect the bank to be doing over the next couple of months is to throw cold water over the idea they might be raising in the July-August timeframe, because I don't expect the Fed to move that quickly."

The Canadian central bank might have been said to be doing precisely that last week in a speech delivered by David Wolf, an adviser to the bank. The former Merrill Lynch Canada chief economist told an Edmonton business audience that the bank is not worried about a housing bubble, and even if it were, it would not raise interest rates to discourage homebuyers.

With the economy in the early stages of a fragile recovery, there is no reason for Carney to be sending any messages about raising rates, say economists.

But they add that Carney is surely thinking about when he will have to, so as to not risk encouraging too much borrowing and triggering the kind of asset bubble that helped to derail the U.S. and then the global economies in 2008.

Although Canada's economy remains weak, the domestic part is relatively strong. Housing is back to pre-recession levels in prices and at record levels in terms of sales. The country's retail sector is also rebounding.

Canada's labour market, although it appears to change course monthly, has been stable in the aggregate since last summer.

The trouble is Carney is already on record as projecting the economy will expand by a full three per cent this year, well above the consensus forecast of 2.6 per cent.

A revision downward at Tuesday policy announcement, or Thursday's more detailed outlook report, would signal to markets that he is in no hurry to raise rates.

"I think they should lower his forecast," said Douglas Porter, deputy chief economist with BMO Capital Markets.

"Spending and housing have come back stronger than anyone expected, but the nature of the rebound we're seeing globally isn't really helping our manufacturers (and exports). The best that could happen for the Canadian economy is if U.S. auto sales were to take off, but I don't see that happening now."

In a report, CIBC chief economist Avery Shenfeld predicted the economy will appear stronger that it is during the first half of the year, but suffer a reversal in the second half as government stimulus, here and in the U.S., begins being phased out.

The early rebound, however, may cause Carney to jump the gun on interest rates, a move it may regret later when higher rates add to the drag, said Shenfeld.

When to raise rates and how much will be among the most difficult decisions facing Carney, and central bankers in the U.S. and Europe, this year, say economists.

Apply the brakes too quickly and too hard, they risk derailing the recovery as the cost of borrowing discourages spending and business investments. Wait too long, as the U.S. Fed did after 9-11, and they encourage the opposite - reckless and risky credit conditions that could lead to another financial crisis, as well as high inflation.

"It's a delicate balancing act," says Orr. "Historically, there a plenty of examples of central bankers getting it wrong."

Organizations: Bank of Canada, U.S. Federal Reserve, Merrill Lynch Canada BMO Capital Markets CIBC

Geographic location: Canada, U.S., OTTAWA Edmonton Europe

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