Bank of Canada to raise rates in late 2007 and 2008 - from RBC

Bank of Canada to raise rates in late 2007 and 2008

Interest rate outlook

Bank of Canada to raise rates in late 2007 and 2008 Canada’s economy is picking up pace with first-quarter GDP growth on track to meet our 2.8% (annual rate) forecast. The economy expanded at a stronger-than-expected 0.4% monthly pace in February, double market forecasts for a 0.2% rise and faster than January’s 0.1% gain. The threemonth running rate clocked in at a 3.6% annualized pace, a solid pick-up from the 2.4% rate in January and sub-2% pace in the final six months of 2006.

Tight labour market conditions and growing incomes are supporting consumer spending and business spending remains firm. The rise in the Canadian dollar may dampen export demand but the slowing is likely to be limited by a strong appetite for commodities, while import demand may prove to be more robust than we had thought. While the trade sector may be a drag on growth in 2007, solid household and corporate balance sheets will more than make up for it. We expect Canada’s economy to grow by 2.5% in 2007 and an even faster 3% in 2008 – this is not new.

What is new is that Canada’s inflation rates, both the all-items CPI and the Bank of Canada’s core measure (CPIX) increased at a faster pace in the first quarter than policymakers expected and evidence is starting to build that these indices will remain elevated during the next few quarters. The all-items index increased at a 1.8% average pace in the first quarter and the CPIX rate at 2.3%, broadly in line with our forecast. Upward price pressures on a trend basis persist with the threemonth annualized gain in core CPI at 2.4% in March (see chart page 7), the fastest pace of increase in four months. We now view the risks that these inflation rates will hold above 2% in 2007 to be biased upward. While the Bank may tolerate higher inflation in the near-term, a persistent run above the target is likely to lead policymakers to view policy to be inconsistent with reaching their medium- term inflation goals. Also, we expect that any surprises to the Bank’s growth outlook will prove to be to the upside, meaning that the economy will move farther into excess demand rather than back to its productive capacity as the Bank expects.

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