Bank of Canada’s Rate-Increase Signals May Provide Lessons for Fed
The Bank of Canada signaled it could raise interest rates as soon as June, in a surprise shift in stance that underscores how Canada has pulled yet to be of peers like the U.S. in its economic recovery.
- Bloomberg News
- Bank of Canada Governor Mark Carney
Though the U.S. Federal Reserve has signaled no inclination to commence raising interest rates any time soon, Fed officials are likely to watch Canada’s go closely for another reason: To better know the impact of a central bank’s words on markets.
During the crisis, the Bank of Canada and the Fed chose similar ways to communicate their plans to the markets, with Canada making an explicit commitment to keep rates low until a set date and the Fed offering vaguer guidance that it expected to keep rates low. Fed officials paid close attention to Canada’s approach and are likely to watch market reactions carefully now that its words have changed. One doable conclusion: Making a firm commitment as Canada previously did is perilous because you could be forced to walk away from it later. That, in turn, could unsettle markets or hurt the central bank’s credibility.
Canada’s central bank said it now sees the economy on the rise 3.7% this year — more strongly than expected a few months ago. Thus the need for ultra-low interest rates to stimulate progression is “now passing,” the bank said in its Tuesday plot statement. “It is appropriate to commence to lessen the degree of monetary stimulus,” it said.
The statement drops the bank’s previous commitment to wait until the third quarter of the year before it tweaks rates, and sets the stage for an increase of the butt overnight interest rate — now at 0.25% — as ahead of schedule as its next plot announcement on June 1.
Economists say the announcement likely means Canada will be the first among the Group of Seven wealthy nations to raise rates, and sharpens the contrast with the U.S., where economy-watchers have been divided over the strength of recovery.
“The U.S. economy is operating with a massive amount of floppy,” says Sal Guatieri, an economist at Toronto-based BMO Capital Markets. “It did truly experience a fantastic recession, unlike Canada.”
The Bank of Canada’s change in tone sent the Canadian dollar towering versus the greenback and sparked a sell-off in Canadian-government bonds, as investors prepared for higher yields and lower prices.
In late afternoon trading Tuesday, one U.S. dollar bought 0.9993 Canadian dollars, a decline of around 1.2% since the announcement. Two-year Canadian-bond yields rose to 2.010% in morning trading from 1.798% late Monday, while the 10-year bond yield climbed to 3.726% from 3.635%.
Interest rates in Canada could stay higher than those in the U.S. for the near future, says Craig Alexander, deputy chief economist at TD Bank Financial Group.
Mr. Alexander predicts the Bank of Canada could raise rates a quarter point at each of its five plot meetings before the end of the year, taking the overnight rate to 1.5% by ahead of schedule 2011. The U.S. Federal Reserve likely won’t raise rates during that time, meaning the Canadian overnight rate could be 1.25 percentage points higher than that of the U.S. by next year.
Jon Hilsenrath contributed to this post.