The Bank of Canada is clear that the next rate move will be up, though it could take a long while.
T he Canadian economy has strongly outperformed the U.S. during the recovery. More recently, some data has shown signs of softening (e.g. a weak July employment report and a drop in business confidence). Still, the Bank of Canada (BoC) Governor Carney clearly stated and maintained his hawkish bias:
To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.
Canadian policymakers are always particularly attuned to developments in the U.S. With the Fed contemplating further quantitative easing, or at the very least, staying on hold for the foreseeable future, any rise in interest rates from the BoC would put additional upward pressure on the Canadian dollar.
In other words, an interest rate hike could have an outsized negative impact on the Canadian economy as the widening in interest rate differentials significantly bids up the Canadian dollar. Canadian policymakers are attuned to this risk, so our base case is that the BoC will continue to threaten to hike rates to persuade households into deleveraging. However, policy is more likely to remain on hold until well into 2013.
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