A speech on Wednesday by Bank of Canada Governor Mark Carney will be closely examined for hints at the future direction of interest rates.Sean Kilpatrick
In April, Federal Reserve chairman Ben Bernanke said the Federal Open Market Committee's pledge to leave the benchmark interest rate low for an "extended period" means at least the period of time between a couple of policy meetings. With eight meetings a year, the FOMC meets once every six weeks. So each time the Fed's policy committee recommits to keeping the federal funds rate exceptionally low for an extended period, investors can bet that rates will remain unchanged for at least a quarter.
So what does the Bank of Canada mean when it says "some of the considerable monetary policy stimulus currently in place will be eventually withdrawn?"
As Bank of Canada Governor Mark Carney prepares for a speech Wednesday in Vancouver, that's the question analysts on Bay Street and Wall Street are striving to answer.
On Tuesday, Toronto-Dominion Bank chief economist Craig Alexander joined the fray, revising his estimate of the next interest-rate increase by the Bank of Canada to early next year from a previous forecast of July.
"We would put the emphasis on `eventually' and only `some,''' Mr. Alexander wrote in a three-page explanation of his revised policy outlook.
The debate about when the Bank of Canada will next raise interest rates comes down the reliability of its models in the choppy conditions in the aftermath of the financial crisis. Standard measures of inflation and the output gap suggest Mr. Carney should be lifting borrowing costs now. But Mr. Alexander is betting that Canada's policy makers have shut down auto-pilot and will guide the economy on intuition and real-time observation.
"There is enormous uncertainty about how the economic and financial events will unfold," Mr. Alexander wrote. "This means that the Bank of Canada has less confidence in its model-based forecasts. In stats-speak, there are enormous confidence intervals around the base case projections. It is also likely that the bank perceives the risks to be asymmetric, in other words the downside outcomes are far more worrying than the upside possibilities."
With inflation expectations well anchored, the Bank of Canada can afford to wait for more clarity on risks such as slower U.S. economic growth and the stronger Canadian dollar, Mr. Alexander says. When the central bank does opt to raise interest rates, it may resist doing so quickly. Mr. Alexander predicts Mr. Carney will go to 2 per cent from the current 1 per cent in quarter-point increments, and then take a pause to reassess. A gradual approach also would limit the upward pressure on the dollar.
Those who predict the Bank of Canada will raise interest rates before the end of the year say policy makers will be pushed to do so by inflation. Mr. Alexander concedes this is the biggest risk to his prediction.
"If solid economic data leads markets to fret about the bank falling behind the inflation curve, then all bets are off and the central bank will start hiking," Mr. Alexander wrote. "The credibility of an inflation fighter is too valuable to lose."