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Interest rate hikes coming but won't be steep through 2011: CIBC World Markets Inc.

TORONTO, Ontario, April 08, 2010 — Expectations that the Bank of Canada will begin raising interest rates this summer are on the mark but investors shouldn't be surprised if rates remain very low by historical standards right through 2011, according to a new report from CIBC World Markets Inc.

While markets may be aggressive in their expectations for rate hikes after the first increase expected in July, "a gradualist approach" is more likely and could see overnight rates at a still-low 2.5 per cent at the end of next year, says Avery Shenfeld, CIBC's chief economist, in the latest Global Positioning Strategy report.

Mr. Shenfeld lists several reasons for Bank of Canada Governor Mark Carney to "take it easy" on rate hikes after July, playing on the title of the classic Eagles song. The factors he sees supporting a more measured pace on rate hikes after the summer include the following:

  • The long path to sustained growth south of the border means an interest rate hike there is likely several quarters away. "Why should Governor Carney care about getting too far ahead of the U.S. Federal Reserve (in raising interest rates)? Because when the Fed is still on hold, it reflects Washington's judgement that a self-sustaining rebound isn't yet assured," says Mr. Shenfeld.
  • Unmatched rate increases in the U.S. could also "send the Canadian dollar into record territory," he adds. "While factories are recovering in Canada alongside a global industrial revival, output remains nearly 20% below the pre-recession peak, and wages are now substantially above those stateside without the productivity gains to match. There's only so much of a competitive challenge that non- resource exporters can take in short order."
  • The recent uptick in inflation is not expected to continue as Canadian production is below its potential. This "output gap" serves to restrain wages and other costs, ultimately reducing the need to hike rates to curb inflation.
  • Federal and provincial belt tightening beginning in 2011 - meaning tax hikes and spending restraint - "could take a huge slice off next year's growth rate. If so, overnight rates might have to remain stimulative, as rates at 2.5 per cent or less would be," says Mr. Shenfeld.
  • Austere foreign budgets will likely impede global growth. "If the U.S., the U.K., and Japan all move from huge stimulus to even modest restraint, Canada will feel it in our export prospects come 2011."
  • Banking reforms in G-20 countries require added capital and reduced leverage that will cut into global bank lending capacity, notes Mr. Shenfeld. "The more credit tightens due to regulatory actions, the less need for central banks to do it through the overnight rate."

A gradual tightening of rates may indeed be good for Ottawa and provincial governments which, as noted elsewhere in the report, are expected to borrow money at elevated levels through 2011 via new bond issuance.

For commodities, higher interest rates are likely to slow rather than kill the current rally. Oil and Industrial metals may even continue to rise as the report notes in past cycles after monetary restraint.

News source: CIBC

 

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