Interest rate hike Tuesday unlikely: experts

Investors and most experts are confident Bank of Canada governor Mark Carney will not announce higher interest rates Tuesday morning.

After slashing its benchmark overnight lending rate to zero during the downturn, the bank began to cautiously raise the rate again in the months that followed.

Generally speaking, a lowering of interest rates encourages businesses and consumers to spend and borrow, which stimulates the economy. On the flipside, central banks raise rates when they want to slow an overheated economy that's causing inflation.

Since September 2010, the rate has been held at 1.0 per cent — and with unemployment hovering above seven per cent and Canada's pace of economic expansion still below the bank's long-term comfort zone, few expect Carney to announce a rate hike on Tuesday morning.

All 32 economists of a Bloomberg news survey on Monday expected Carney to stand pat on Tuesday. The survey average expects Carney to raise rates to 1.25 per cent by May and to two per cent by December 2011. 

"Beyond the January meeting, there is a ton of debate. I've never actually seen anything quite like the spectrum of forecasts we have at this point," said Doug Porter, deputy chief economist at BMO Capital Markets.

"BMO's view is kind of in the middle of the pack, we have them starting to raise rates in May, but some see it as early as March. Some see it as late as September, so forecasters are really of a split decision on this one."

Bank of America Merrill Lynch Canada analyst Sheryl King is slightly more bullish on the odds of Carney hiking rates sooner rather than later, because she said policy-makers have overestimated how much slack is left in the economy.

"We're closer to the output gap than the Bank of Canada is assuming," she said recently. If the economy moves ahead it will cause a surge in the core inflation rate, which the central bank pays close attention to. Although she stops short of predicting a hike on Tuesday, her prediction of a 2.5 per cent rate by December is more aggressive than that of most economists.

Employment rebound

In a speech in December, Carney said future rate hikes would be "carefully considered." While some policy members are worried about putting the brakes on the economy too soon, in an ideal world,  higher rates give the central bank more wiggle room to act as circumstances warrant. "In the longer term the bank is simply not comfortable with rates at these very low levels," Porter said.

The bank finds itself in the strange position of having its key rate well below the rate of inflation, which in November stood at an annualized rate of two per cent.

"But the conundrum or dilemma is that they're dealing with a situation where our largest trading partner, the U.S., is in an absolute zero rush to raise interest rates and as Carney himself has said, there's only so much the bank can separate itself from the Federal Reserve," Porter said.

Last week, the think-tank C.D. Howe Institute recommended that Carney hike the key rate on Tuesday to 1.25 per cent and aim for 2.5 per cent by January 2012. Canada is the only G7 economy to have made up all of the employment and output losses it suffered during the recession.