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The Canadian dollar rose sharply Tuesday as the Bank of Canada warned
that it will be raising interest rates.
At midday, the dollar was up 1.63 cents to 100.17 cents US.
The Bank of Canada kept its key lending rate unchanged Tuesday, but
warned that its low-rate policy has a limited future.
The bank held the overnight rate at 0.25 per cent, as economists had
expected.
But with the economy recovering and inflation running above the
bank's two per cent target, the need for rock-bottom lending rates "is
now passing," it said in a statement.
The extent and timing of any change in the key rate "will depend on
the outlook for economic activity and inflation," the bank said. The
bank also noted growth is "proceeding somewhat more rapidly" than it
expected earlier this year, increasing the chance of a rate rise in the
early summer.
"Simply put, this statement marks a dramatic change in tone by the
bank, and doesn't rule out possible 50 basis point moves," said Douglas
Porter, deputy chief economist with BMO Capital Markets, in a
commentary.
Porter predicted a June rate hike is now "likely," adding that the
central bank is clearly much more concerned about inflation than
previously indicated.
The bank sets a target level for the overnight rate, which is often
called the key interest rate or key policy rate because it indicates the
bank's thinking about the economy.
'Simply
put, this statement marks a dramatic change in tone by the bank, and
doesn't rule out possible 50 basis point moves.'—Douglas
Porter, BMO Capital Markets
The overnight rate is
the interest rate major financial institutions charge each other for
one-day loans.
The rate has been at a very low 0.25 per cent since April 2009, when
it was cut from 0.50 per cent as the recession worsened. It was at a
recent peak of 4.5 per cent in October 2007.
The bank's "extraordinary policy" of ultra-low rates was introduced
to boost the recovery, the statement said.
The bank is forecasting growth of 3.7 per cent this year, reflecting
stronger global activity, strong housing activity in Canada and the
bank’s conclusion that policy stimulus advanced some spending into late
2009 and early 2010.
It's forecasting that Canadian economic growth will slow to 3.1 per
cent in 2011 and 1.9 per cent in 2012.
Competing pressures
Bank
governor Mark Carney is juggling competing pressures: the need to
control inflation with a higher rate; the need to keep the cost of loans
low to encourage business and consumer borrowing; and the strong
dollar.
A bank rate increase could push the dollar even higher, hurting
exports and jobs. While recognizing that growth is strong, the bank
warned Tuesday about economic negatives: "the persistent strength of the
Canadian dollar, Canada’s poor relative productivity performance and
the low absolute level of U.S. demand."
Although Carney expressed concern about inflation in March, the bank
said it is expecting the rate to ease slightly in the second quarter,
and remain slightly above the target two per cent rate this year before
easing in the second half of 2011.
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