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A must read if you have a variable rate mortgage

General Angela Calla 2 Mar

March 2 (Bloomberg) — The Bank of Canada kept its benchmark interest rate at a record low today, and said that inflation and economic output have been higher than policy makers expected, signaling rate increases in coming months.

The target rate for overnight loans between commercial banks remained at 0.25 percent, where it’s been since April, as predicted by all 22 economists surveyed by Bloomberg. The bank also repeated a pledge to leave it unchanged through June unless the “current” inflation outlook shifts.

The economy grew at a 5 percent pace in the fourth quarter, Statistics Canada said yesterday, faster than the bank’s Jan. 21 prediction of 3.3 percent. Inflation has also accelerated close to the central bank’s 2 percent target, suggesting the bank could raise rates before the June commitment ends, said Derek Holt, an economist at Scotia Capital in Toronto.

“They are signaling a bias shift here that primes the path for rate hikes, potentially earlier than markets are expecting,” Holt said in a telephone interview. “They could hike now as far as I’m concerned.”

The Canadian dollar gained 0.9 percent to C$1.0316 against the U.S. currency at 9:14 a.m. in Toronto, from C$1.0414 yesterday.

Firmer Inflation

“Core inflation has been slightly firmer than projected, the result of both transitory factors and the higher level of economic activity,” the Ottawa-based bank said in a statement. Fourth quarter growth came from “vigorous domestic spending and further recovery in exports.”

The bank said the expansion, which was the fastest in almost a decade, pushed Canada’s output to a level “slightly higher than the Bank had projected.” Governor Mark Carney has said there must be a transition towards private expenditures instead of government stimulus to create a sustained recovery.

The bank’s statement dropped a reference made in January to inflation risks being “tilted slightly to the downside.” The statement also omitted a reference to the central bank having “flexibility” even with the key interest rate close to zero.

“What’s not in the statement is at least as important as what’s in it,” Holt said. “Removing the reference to inflation risks to the downside, that signals the bank is worried that core inflation is overshooting its expectations.”

Sending a Message

“It doesn’t take huge changes in words to send a message,” said Doug Porter, deputy chief economist with BMO Capital Markets in Toronto before the announcement. “They have to slowly but surely set the landscape for rate hikes.”

Canada’s annual inflation rate was 1.9 percent in January, the fastest pace in more than a year, Statistics Canada said Feb. 18. The so-called core inflation rate, which excludes gasoline and seven other volatile items, rose 2 percent, underscoring what Carney has called “stickiness” in that rate.

Carney has also said Canada’s economy will operate with “slack” through the middle of 2011. Growth will be curbed by the Canadian dollar’s strength and a low volume of U.S. orders, the bank reiterated today. Canada’s dollar appreciated 25 percent against the U.S. dollar over the past 12 months to about 96.6 U.S. cents.

“It’s better to move sooner than later but be less aggressive,” said Yanick Desnoyers, assistant chief economist at National Bank Financial in Montreal. He predicts an April rate increase.

Spare Capacity

Statistics Canada also revised its earlier growth figures to show the country’s first recession since 1992 was deeper than thought, with a 7 percent annualized contraction in the first quarter of last year.

The capacity left in the economy means the bank can wait until after its June commitment ends to raise rates by a quarter point, Porter said. “It would take an awful lot to push the bank into an earlier move,” he said.

The bank should raise its key lending rate in half-point moves after June, University of Western Ontario professor Michael Parkin said in a Feb. 23 paper. Taking the rate to 3.75 percent by mid-2011 is needed to keep inflation in check as an economic recovery is “taking hold,” Parkin wrote for the C.D. Howe Institute, a research group chaired by former Bank of Canada Governor David Dodge.

The Bank of Canada will probably raise the key rate to 0.75 percent in the third quarter and to 1.25 percent by the end of the year, according to the median forecast of economists surveyed by Bloomberg News. A separate survey for the U.S. shows economists don’t expect the Federal Reserve to raise its benchmark rate to 0.75 percent until the fourth quarter.