Higher interest rates, but why?
Despite our protests on this blog, and Erin Weir chaining himself to the central staircase of the Bank of Canada, our hawks at the Bank raised interest rates today. That is, it raised the overnight rate by a quarter point to 4.5%. The Bank’s press release is a bit unusual in that there is no obvious reason why this move is being made:
The Canadian economy is now projected to grow by 2.5 per cent in 2007, somewhat stronger than was expected in April, and to grow somewhat more slowly in 2008 and 2009 than previously projected. In this new projection, higher interest rates across the yield curve and a higher assumed range for the Canadian dollar of 93 to 95.5 cents U.S. act to moderate growth in 2008 and 2009 to an average of about 2 1/2 per cent. This brings aggregate demand and supply in Canada back into balance in 2009.
Inflation is projected to be slightly higher and more persistent than in the April MPR. However, as excess demand diminishes, total CPI and core inflation should decline to 2 per cent by early 2009.
Canadian growth is not projected to be stellar this year (and if Saudi Alberta is taken out of the equation the growth rate is even lower), slowing in 2008 and 2009. The dollar is way up, compounding the negative hit in central Canada. And given that inflation, at 2.2% in May, is in fact quite low, it is hard to see what the fuss is all about. In fact, US inflation in May was about half a percentage point higher, at 2.7%.
The Globe’s coverage quotes another industry analyst, without reference to his potential conflict of interest, to let us know that more hikes are on the way, and the bank itself to suggest that even that is not the end of this road:
â€œWe are expecting another 25-basis-point rate hike on Sept. 5 to 4.75 per cent, followed by a brief pause to gauge the effect of both the higher interest rates and the recent appreciation of the Canadian dollar,â€ said Ted Carmichael, chief economist of J.P. Morgan Securities Canada Inc., in a note.
… â€œSome modest further increase in the overnight rate may be required to bring inflation back to the target over the medium term,â€ the bank said in a statement. The sentence marks a shift in the bank’s stance: in its previous statement in May, it said increases would be needed in the â€œshort termâ€ and it didn’t use the word â€œmodestâ€ â€” the new statement thereby suggesting that interest rates aren’t poised to soar.
The Globe story, apparently some editorializing by the author, says the Bank is concerned that “price increases could spiral if it doesn’t act”. Spiral? Concern about higher inflation is one thing, but what data suggest that the very modest rise in inflation over the past year will somehow lead us into an inflationary spiral?
The Globe does report that “Tuesday’s move is bound to prove unpopular with exporters, which have watched this year’s 10.7-per-cent surge in the Canadian dollar with growing alarm.” On the other hand, it all depends on who you are. I went to the US last week, and I must say that the high dollar was pretty sweet, as you can almost think of the dollars being at parity. But this, I imagine, is cold comfort for manufacturers and exporters in central Canada.
PS. Erin Weir did not actually chain himself to the Bank of Canada.