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Bank of Canada Ponders a Rate Hike |
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January 20, 2011
 The Bank of Canada is trying to decide between raising interest rates and holding them static.
We anticipate the BoC will hold until the second half of 2011 rather than risk a setback if the economy deteriorates.
Higher rates could help slow credit growth at a time when Canadian households are becoming overleveraged.
Yet raising rates sooner will add upward pressure on the loonie, undercutting exporters who are expected to lead the recovery.
According to the Bank of Canada's most recent Monetary Policy Report, the central bank is trying to decide between raising interest rates and holding them static. We anticipate the BoC will do the latter until the second half of 2011, preferring to remain cautious rather than tighten now and be forced to pause later should conditions deteriorate.
Arguing for tighter monetary policy is concern that Canadian households are becoming overleveraged. The ratio of debt to disposable income hit 148% in December, and personal bankruptcies have risen over the past two years. Additionally, credit is growing faster than income. A spending pullback by stretched consumers could pose a threat to Canada's recovery, since private consumption comprises 60% of aggregate demand. Higher interest rates would slow bank lending and credit growth. The Ottawa government has already taken steps to curb rising debt levels such as lowering the maximum loan-to-value ratio on home equity loans to 85% from 90%.
On the other hand, the central bank expects business investment and exports to drive the recovery this year. Raising rates would add upward pressure on the Canadian dollar's exchange value, hurting exporters and threatening growth. Canada's relatively weak pace of productivity growth is already a weight on the country's export sector; an appreciating loonie could exacerbate the problem.
BoC policymakers also see significant slack in the economy; meanwhile, inflation expectations are well anchored and on pace to reach the central bank's 2% inflation target by the end of 2012. We therefore look for rates to hold steady over the next several months. |
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About the Author
Adam Goldin is an economist with Moody's Analytics. He covers the fiscal condition of state and local governments, U.S. state and regional economies in Washington and South Carolina, and Belgium. Before joining Moody's Analytics, he analyzed municipal bond credit risk for FGIC and Moody's Investors Service. He has master's degrees in economics from Fordham University and international relations from George Washington University, and a bachelor's degree in economics and political science from Binghamton University.
Email Adam Goldin |
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