OECD sees Canadian interest rates rising

The Bank of Canada kept its trendsetting interest rate at one per cent on Wednesday, where it's been for more than three years. Adrian Wyld/The Canadian Press

OTTAWA – The Bank of Canada may need to start hiking its trendsetting interest rate within the next year and steadily push it to 2.25 per cent by the end of 2015, according to an international think-tank representing the world’s leading economies.

The central bank has kept its policy rate fixed at one per cent since September 2010, leading to one of the most stable and favourable borrowing environments in many decades.

But the Organization for Economic Co-operation and Development said in a report Tuesday that with the Canadian and global economies about to return to more stable and predictable growth, that period is coming to an end.

The Paris-based organization notes that Canada’s central bank has declared that given continued slack in the economy and below-target inflation, interest rates will not be raised for an extended period.

“However, with spare capacity narrowing by the end of 2015, monetary policy tightening may need to begin by late 2014 to avoid a buildup of inflationary pressures,” it said.

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“It is assumed in the projection that the first policy rate increase occurs in the fourth quarter of 2014 and that the rate rises steadily to 2.25 per cent by the end of 2015.”

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Such an increase would likely lead to a corresponding hike in variable rates for Canadians and higher fixed mortgage costs, analysts say.

However, most economists believe the central bank won’t budge off one per cent until the first quarter of 2015, and perhaps even later.

In an advisory to clients Monday, Bank of Montreal economists Michael Gregory and Benjamin Reitzes said the central bank is unlikely to begin tightening until its U.S. counterpart has stopped easing, Canada experiences at least a couple of quarters of above-potential growth and until core inflation, now hovering just above one per cent, climbs closer to the bank’s two per cent target.

“We suspect the bank will move cautiously for fear of fuelling too much Canadian dollar strength. We have the BoC hiking twice during 2015 (to 1.5 per cent), before the Fed joins the tightening party,” they wrote.

The OECD is also worried about the recent revival of Canada’s housing market, although the report most likely did not take into account last week’s news that existing home sales had fallen back by 3.2 per cent in October, the first dip since February.

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“If house-price pressures re-emerge, further macro-prudential measures may also be required,” it said.

The Bank of Canada can restrain the housing market by hiking interest rates, but has signalled that federal Finance Minister Jim Flaherty is in the best position to act because he can hone in directly on the problem. The minister reiterated last week that the government is prepared to tighten mortgage rules for the fifth time in about as many years if it becomes necessary.

Overall, the OECD’s latest economic outlook sees momentum in Canada’s recovery, returning to 2.3 per cent growth in 2014 and 2.6 per cent in 2015 following two slack years of 1.7 per cent growth.

“The pause in economic recovery since early 2012 has continued this year,” it notes.

“(But) recovery in export markets and signs that Canadian firms are expanding into the fastest-growing emerging markets and investing more in innovation, marketing and efficiency improvements, should boost export growth.”

This will eventually lead to a pick up in business investment, it adds.

The outlook and the analysis is similar to what the Bank of Canada issued last month and what Flaherty has plugged into his budgetary estimates for this year.

The OECD sees the global economy as a whole strengthening in 2014 and 2015, but it cautions the recovery will be modest, in part because emerging markets have stopped producing near double-digit growth.

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Of advanced countries, it puts  U.S. growth near the head of the class at 2.9 per cent next year, accelerating to 3.4 in 2015. The euro area will also emerge from recession, posting a one per cent advance in 2014 and 1.6 in 2015, the report predicts.

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