BoC rate hike not likely in short term

Things are definitely looking up for the Canadian economy, but don’t bank on interest rates rising anytime soon.

With Europe’s credit mess spilling over and the faltering U.S. recovery eliciting serious talk about QE3, it’s pretty much unanimous the Bank of Canada will stand pat when setting its policy direction next Tuesday and may not budge until later this year or next year.

“The arguments are there for the Bank of Canada to start hiking rates next week, but we increasingly think that this fall might even be too early given the problems we are seeing in the global economy,� said Jimmie Jean, an economic strategist at Desjardins Capital Markets based in Montreal.

Despite encouraging news over the past week, including solid housing and jobs numbers and improving business sentiment that suggest Canada is bucking the global slowdown, not one of 37 economists and strategists recently surveyed by Reuters expects the Bank of Canada to hike rates July 19.

While some do expect a 25-basis-point increase in September, the median forecast predicts the central bank will leave its key policy rate at 1% until the fourth quarter.

Mr. Jean has pushed his rate-hike expectations out to December. In his mind, as positive as Canadian economic data have been lately, there is no urgency for the Bank of Canada to tighten policy when both Europe and the United States, the world’s two biggest markets, are struggling.

If Europe’s sovereign crisis results in a country defaulting on its debt or escalates in some other manner, it could shock the global financial system by straining funding markets for banks — Canadian ones included — to create another liquidity crunch, he said.

Meanwhile, prospects of the U.S. economy regaining its footing in the second half of the year seem to be diminishing, especially following last week’s dismal jobs report and now U.S. Federal Reserve chairman Ben Bernanke has raised the possibility of another round of quantitative easing.

“That was pretty firmly ruled out just a few weeks ago and now the possibility is being raised,� Mr. Jean said. “There’s no question that if the Fed goes QE3, the Bank of Canada is not going to hike rates.�

Karen Cordes Woods, a financial markets economist at Scotia Capital Markets said the risks of tightening monetary conditions currently outweigh the benefits and she doesn’t think the Bank of Canada will move on rates until the second quarter of 2012.

She said material tightening is being imposed on the economy from fiscal retrenchment and the strength of the Canadian dollar to stricter mortgage lending guidelines and elevated commodity prices that continue to crowd real wage growth despite the improvements in the labour market.

Although there is recent evidence of inflation creeping into the economy, it’s not nearly enough to justify a rate hike and Ms. Cordes Woods believes a move to tighten by the Bank of Canada would only put more upward pressure on the dollar and represent an unwanted headwind for the economy.

“The Bank of Canada still has time to stay on the sidelines,� she said. “They will do what they see fit given the conditions.�