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Bank of Canada raises interest rate, commercial banks follow

Blog by Shaun Kimmins | June 1st, 2010


OTTAWA — For the first time in nearly three years, Canada's central bank has begun cranking up its key lending rate from historic lows, even as the country's stronger-than-expected economic rebound is being overshadowed by an "uneven" global recovery and the European debt crisis.

The Bank of Canada on Tuesday raised its overnight target rate a quarter-point to 0.5 per cent.

Although concerns about Europe and other things might delay any further moves by the Bank of Canada to raise borrowing costs, consumers will feel an immediate impact with major banks already raising their prime lending rates, effective Wednesday.

All the country's major banks have raised their prime lending rates 25 basis points to 2.5 per cent. The prime rate is generally the base interest rate from which other rates for lending are derived, such as for mortgages, loans or credit cards.

The rate changes made by Canada's major banks are generally made in close concert with each other and with the Bank of Canada.

Though the Bank of Canada delivered its widely expected interest-rate increase Tuesday, it did come with a cautious accompanying statement that suggested the hike was a reluctant one at best. Further interest-rate hikes this year were thrown into question.

"This decision still leaves considerable monetary stimulus in place, consistent with achieving the two per cent inflation target in light of . . . the strength of domestic spending and the uneven global recovery," the central bank said in a statement.

Bank of Canada governor Mark Carney could be hedging his bets, given the state of Europe's financial system and the possible negative spillover onto global credit markets. The cost of borrowing among banks has crept up, which analysts suggest is a sign that credit conditions are becoming more difficult.

The central bank's statement seemed designed to give it as much flexibility as possible in setting interest rates in the future.

"Those looking for a clear roadmap, or GPS, for the central bank's tightening path will be sorely disappointed by the cautious statement," said Douglas Porter, deputy chief economist at BMO Capital Markets.

"The bank has left its options wide open even on the July rate decision. While we still expect a followup rate hike at that time, we continue to believe that the bank will take a pause at some point this year, particularly with the (U.S. Federal Reserve) likely on hold (with interest rates) until 2011."

Central bank statements that accompany rate hikes generally cite the overall strength in the economy and how it is pushing up inflation. In contrast, Tuesday's bank statement was ripe with caution, citing the "uneven" global recovery, the "considerable uncertainty" in the outlook, and how future rate decisions would be "weighed carefully" against domestic and global conditions.

"I must say I have never seen a Bank of Canada statement that was so front and centre about what is going on outside of our borders," said Sebastien Lavoie, economist at Laurentian Bank Securities.

Porter said the central bank might have felt as if it was cornered into a rate hike Tuesday after it hinted toward rising interest rates in April and talked about reducing stimulus.

Tuesday's rate hike made Canada's central bank the first among its Group of Seven peers to boost its benchmark rates post-recession.

Global stock markets have declined recently over concerns that the fiscal drag from Europe will weigh heavily on global economic growth. Adding to these woes are questions about Europe's banking system.

On Monday, while most Canada posed impressive 6.1 per cent annualized growth for the first quarter, the European Central Bank warned the continent's banks would need to write off roughly $237 billion U.S. in bad debts and could face problems selling bonds as governments flood markets.

In its latest global outlook, Bank of Nova Scotia said the European Union would bear the coming economic headwinds.

"The global recovery has been dented but not derailed," it said, adding emerging economies are picking up enough steam to offset Europe's expected meagre output.

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