Canada becomes first in G7 to raise interest rate

01 June 2010 20:13  [Source: ICIS news]

TORONTO (ICIS news)--The Bank of Canada on Tuesday raised its key overnight interest rate by 25 basis points to 0.50% - the first increase in three years and the first interest hike among G7 central banks following the recession.

But some analysts said the increase may have been premature, given the European debt crisis.

The Bank of Canada said that even with the rate hike, there was still considerable monetary stimulus in place.

Further rate increases would have to be “weighed carefully” against domestic and global economic developments, it said.

Global economic recovery was proceeding, but it was “increasingly uneven across countries”, the bank said.

While emerging economies had strong momentum and the US and Japan saw some consolidation in their recoveries, Europe faced the possibility of renewed weakness, the bank said.

So far, however, the spill-over into Canada from events in Europe had been limited to a modest fall in commodity prices and some tightening of financial conditions, it said.

Patricia Croft, an economist with Toronto-based RBC Global Asset Management, said it was time for Canada to end its period of “emergency interest rates” as real interest rates – the nominal rate minus inflation – were negative, which was “highly stimulative.”

Further increases to higher rates would likely be “very slow and very cautious,” which would make the hikes bearable for homeowners and their mortgages, she said.

Croft said other G7 central banks were not likely to follow Canada’s move.

Other analysts said given the European debt crisis and the prospect of lower growth in Canada, there was a case for the bank to have left the rate in place.

“We are looking at a significant fiscal tightening in Europe, which is going to slow growth down,” with deflationary forces in Europe being exported to North America, Brian Bethune, an economist with US forecasting firm IHS Global Insight, said in a webcast briefing.

The situation in Europe - in particular, the sharp and sudden plunge of the euro - was a shock North American companies had to adjust to in coming months, he said.

While Canadian first-quarter growth was 6.1% on an annual basis, a good part of that was due to the Vancouver 2010 Winter Olympics, as well as restocking of inventories, Bethune said.

Excluding those two factors, underlying growth was “more like 2.5%”, and going forward both Canada and the US could expect a “pretty significant slowdown” in the rate growth, he said.

“That’s why a this point it does not make sense to tighten monetary policy … [and] slow down growth even further,” Bethune said.

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