Reuters - September 08, 2010
The Bank of Canada raised its benchmark interest rate for a third consecutive time on Wednesday and sounded surprisingly hawkish despite predicting a more gradual than expected economic recovery.

The central bank nudged its overnight rate target up 25 basis points to 1 percent and, contrary to most economists' expectations, did not signal a pause for its next decision in October. It said rates remained "exceptionally stimulative" but kept all options open due to doubts about the U.S. and global recoveries. "Any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook," it said in a statement.

The Canadian dollar jumped to a session high against the U.S. currency, touching $1.0369 to the U.S. dollar just before the announcement. Short-term money market rates and bond yields also jumped. The yield on the rate sensitive two-year Canadian government bond rose to 1.377 percent from 1.266 percent just before the news.

"Generally it's a very upbeat statement, it's a little more hawkish than I anticipated," said Derek Burleton, deputy chief economist at TD Bank Financial Group. "This will cast some uncertainty about whether the bank will pause at the next fixed announcement date."

The Bank of Canada has raced ahead of its Group of Seven peers in raising borrowing costs after the global financial crisis. It lifted its policy rate on June 1 from an all-time low of 0.25 percent and raised rates again on July 20.

The U.S. Federal Reserve, by contrast, has raised the prospect of further easing and counterparts in Europe and Japan are likewise far from ready to tighten monetary policy.

Markets had seen Wednesday's rate hike as a close call because of rising fears of another U.S. economic downturn. Twenty-five out of 41 forecasters in a Reuters poll had predicted a hike. Most analysts also expected the bank to hold rates steady in October and December and possibly longer as it tracks developments elsewhere.

After the rate announcement, markets were pricing in about a 68 percent probability the bank would leaves rates unchanged in October based on yields on overnight index swaps, according to a Reuters calculation.

"As it stands right now, our official call was for the Bank to remain on hold for the next few meetings, but that's obviously something we have to review in light of the statement and as economic figures roll in in the weeks ahead," said Doug Porter, deputy chief economist at BMO Capital Markets.

The Bank of Canada said the 1 percent rate is "consistent with achieving the 2 percent inflation target in an environment of significant excess supply in Canada." The language was similar to that used in its last rate announcement on July 20. But the bank omitted any reference to weighing any further rate hikes "against domestic and global economic developments."


It acknowledged that the economic recovery was losing slightly more steam than it had anticipated just six weeks ago. Second quarter growth disappointed at a 2 percent annual rate versus the bank's 3 percent projection. The bank will revise its official forecasts next month.

It blamed the weaker economy in the United States, which buys three-quarters of Canadian exports, for the tepid rebound in Canada. High U.S. unemployment is holding back spending by individuals and businesses, it said. While exporters may take a beating, the bank sounded upbeat on domestic consumer spending and business investment. "Going forward, consumption growth is expected to remain solid and business investment to rise strongly," it said.  

Most recent U.S. data have dampened fears of a double-dip recession but the recovery there is still wobbly, making it uncertain whether the U.S. Federal Reserve will see fit to take further action to drive down already rock-bottom borrowing costs.

The European Central Bank kept euro zone rates at a record low of 1 percent for the 16th month running last week and extended its program offering liquidity to banks.

The Bank of Japan stood pat on monetary policy on Tuesday but set the stage for possible easing next month.

Canada's commodity exporting economy has been more akin to that of Australia, which hiked rates 150 basis points between October and May but has since moved to the sidelines.