February 26, 2010
By Todd Hirsch
Alberta Business Columnist
CALGARY, AB, Feb. 26, 2010/ Troy Media/ — The chatter around water coolers and board room tables these days may still be focused on Olympics but, shortly after the Games wind down and the closing ceremonies wrap up, everyone will get back to that other favourite topic du jour: where are interest rates going?
Let’s start with what we know for sure:
Currently, the Bank of Canada’s overnight rate – which is the trend-setting rate that influences (but does not dictate) all other borrowing rates in the economy – is still at a record low of 0.25 per cent. It’s been there since last April when central banks all around the world were chopping interest rates as quickly as they could, a kind of life preserver to the global economy that was quickly being washed under the waves.
World economy has found its feet
We also know that the global economy has found its feet, led by growth in the emerging economies. Many threats lurk in the shadows, ready to ambush the global recovery. Commercial real estate in the US, the situation in Greece and Portugal, and protectionist trade barriers going up all around us come to mind. But even if the recovery does stall out, there is some degree of confidence that the worst is behind us.
As well, we know that the Bank of Canada has been sticking with its conditional commitment to keep the overnight interest rate steady until at least June of this year. But with rates at rock bottom, we know with certainty that the only direction they can go is up.
We know that inflation is still dormant in North America: Even if it may show an occasional uptick from month to month, it’s mostly due to gyrating gasoline prices, not any fundamental increase in consumer demand. There is still a lot of underutilized capacity in Canada and the output gap is still positive, which is economist talk for slack.
Finally, we know for sure that June 1 is only three months away.
That’s about all we know with complete certainty. As always with economics, it’s the things we don’t know that make for interesting water cooler talk.
We don’t know, for example, what will transpire between now and June. Commodity prices seem to be gaining some strength, especially crude oil, but demand could falter if the situation in the US turns sour. The American economy has been growing, but only on the shoulders of Washington’s spending spree and bail-out programs. Consumers in the US are still reeling with high unemployment and maxed-out credit cards. Growth in consumer spending or even demand for petroleum products will probably remain weak for some time.
China, on the other hand, is dealing with a different problem: trying to cool its economy a bit. With asset prices soaring and inflation picking up, Chinese officials are rightfully nervous about bubbles building. They’re tapping on the brakes.
In other words, demand for Canadian commodities and other exports could still falter in the months ahead.
We also don’t know what will happen with the Canadian real estate market. Prices and sales have been astounding in 2009, and there’s been plenty of worry over bubbles building. While new measures have been put in place recently by Ottawa to calm the market down a bit, we don’t know if prices will continue to rocket ahead or not.
Finally, there is much uncertainty around what will happen with the US dollar, and by extension, the Canadian dollar. The American greenback slumped in 2009, but nervousness around what may happen to sovereign debt in places like Greece has some investors piling back into the safe haven US dollar. So, we’ve seen corresponding ups-and-downs in the Canadian dollar as well. While it does not target a value for the Canadian dollar, there will be much hollering if interest rate increases in Canada lift the loonie well above par.
Interest rate increases this summer or fall
So, weighing what we know with what we don’t know, the most we can say about interest rates is that we are likely to see the Bank of Canada start raising rates in the summer or early fall of 2010. They just cannot stay at the crisis-level rate of 0.25 per cent for much longer.
The Bank will be reluctant to raise rates suddenly or dramatically, since rates in the US probably won’t start climbing as soon (as per Mr. Bernanke’s comments this week). Big jumps in rates will prompt corresponding jumps in the Canadian dollar, and would slam the brakes on a very fragile recovery.
Yet if rates must eventually return to a neutral level of around three to four per cent, the Bank will want to put some steady pressure on those rates, lifting them by 25 to 50 basis points at a time. A year from now, barring another major economic catastrophe, we can expect the Bank’s overnight rate to be 100 to 150 basis points higher than it is today.
Todd Hirsch is Senior Economist with ATB Financial
Channels: The Calgary Beacon, February 28, Canada Free Press, March 4, the Edmonton Journal, March 8, Portage La Prairie, March 10, the Yorkton News Review, March 11, the Slave Lake Lakeside Leader, March 17, the Grande Cache Mountaineer, March 30, 2010