Canada's lending rate expected to rise

Canada appeared headed toward the distinction of becoming on Tuesday the first G8 member to increase interest rates since the financial crisis in 2008.

Statistics Canada reported Monday that the economy grew in the first quarter by a rate that would reach 6.1 per cent, if extrapolated over the whole year.

Most economists had expected the gross domestic product — the value of all goods and services produced in the economy — to grow by 5.8 per cent annualized.

The GDP number followed a 4.9 per cent rise in the fourth quarter of 2009.

The strong GDP number has increased pressure on Bank of Canada governor Mark Carney to raise the bank's benchmark interest rate, the bank rate, by 0.25 basis points — one quarter of a percentage point — to 0.50 per cent at its regularly scheduled interest rate announcement at 9 a.m. ET.

The bank rate is the target rate the Bank sets for overnight loans made by the commercial banks to each other.

Banks make overnight loans to each other to settle accounts when all cheques and transfers among them have been cleared.

Adding to the good news is the fact that the labour market has already recouped about 70 per cent of the jobs lost during the slump and new figures for May are to be released on Friday.

Some analysts had expected Europe's debt crisis might delay the expected rate hike but "the exceptionally strong growth in the first quarter … may be enough to push the balance of evidence in favour of a rate hike of 25 basis points," ATB Financial senior economist Todd Hirsch said.

"It's almost a given that the Bank of Canada will raise interest rates by 0.25 per cent," Vancouver-based Citizens Bank said in a commentary.

"Under normal circumstances, a 50-basis point hike would be expected," it said, "however, in deference to the possibility of further contagion of the European debt crisis, a 0.25 per cent increase would be a balanced response," it said.

"Nobody could really argue that a quarter-point rate hike would be fatal now," CIBC World Markets chief economist Avery Shenfeld said.

"The Bank of Canada was already quite confident that the Canadian economy was no longer in need of record low interest rates," Shenfeld told CBC News.

"The question really is about the longevity of this expansion and the risks from abroad," he said. "But at this point, I don't think a rate hike would be too problematic for the economy so it looks like [the Bank] has a green light to hike rates."

Shenfeld did not expect an increase of more than 0.25, however, given that is what the market is expecting and it was unlikely the Bank "would want to surprise investors with a tougher dose of medicine at this point."

A rate hike will likely result in comparable increases to the prime rate and variable mortgage rates charged by Canada's chartered banks and other lending institutions.

But given recent weakening in bond yields accompanying fears about Europe's debt crisis, longer-term fixed mortgage rates may be unaffected initially, analysts said.

Economists will also be closely watching the commentary released by the Bank at the same time as its rate announcement for clues to how it views the potential of the European debt crisis to slow global demand.

Europe accounts for only about eight per cent of Canada's foreign trade, but the effects on the country's trading partners could be more substantial.

European bank losses could reach $250B 

On Monday, the European Central Bank warned of potential bank losses of 195 billion euros — $250 billion Cdn. — over the next 18 months.

Even if no crisis emerges, analysts expect the global recovery to moderate as many governments in Europe move to cut back on spending in the face of unsustainable deficits and debt loads.

The GDP data lifted both the dollar and the Toronto Stock Exchange Monday, with the S&P/TSX composite index closing up 91.6 points, or 0.8 per cent, to 11,763.0, and the dollar ahead 0.77 of a cent to 95.83 cents US.

The bank rate has not changed since April 2009. Bank governor Mark Carney on April 20 made a "conditional commitment" to keep rates unchanged until July, citing high-than-expected inflation, but later said a rate increase wasn't "preordained."