Bank of Canada raises central rate
As widely expected, the Bank of Canada again hiked its benchmark overnight lending rate by one-quarter of a percentage point to three per cent on January 24th. The trend-setting Bank rate, which is set one-quarter of a percentage point above the overnight lending rate, now stands at 3.75 per cent.
It was the fourth increase of one-quarter of a percentage point since September 2005, when Canada's central bank began to raise the overnight lending rate for the first time in almost a year. At that time, it said the economy was running near full capacity. Since then, the Bank has said the economy is now running full tilt and faces capacity constraints. Further interest rate increases are anticipated in the coming months to head off inflation pressures.
“In line with the Bank's base-case projection and current assessment of risks, some modest further increase in the policy interest rate would be required to keep aggregate supply and demand in balance and inflation on target over the medium term,” the Bank of Canada said in a statement.
“The Canadian economy expected to grow slightly faster than the estimated non-inflationary rate of 2.9 per cent this year,” said CREA Chief Economist Gregory Klump. “Given the tightness of Canada's product and labor markets, the Bank of Canada continues to signal its intention to keep hiking its trend-setting Bank rate. To keep inflation under wraps, the Bank rate is widely expected to be hiked by a further one-quarter of a percentage point in March.”
The core inflation rate is targeted by the Bank of Canada at between one and three per cent. At the end of 2005 stood at 1.6 per cent – below its midpoint. Although a short-lived spike in energy prices temporarily pushed up overall inflation, it has so far failed to reignite inflation expectations or cause core inflation to accelerate because core inflation does not include volatile food and energy prices.
Analysts believe that further increases in U.S. interest rates are nearly done. Combined with further expected increases in Canada's Bank rate, the Canada-U.S. currency exchange rate will remain strong. A strong Canadian dollar will also help keep inflation under control.
“Since bonds respond to inflation expectations and mortgage rates track bond yields, we expect the five year conventional mortgage to rise by no more than another one-half of a percentage point in 2006,” said Klump.
At the end of 2005, the conventional five-year conventional mortgage rate stood at 6.3 per cent. Stiff competition among mortgage lenders, however, continues to help borrowers negotiate discounts off the advertised rate. “Higher mortgage rates are expected to gradually cool resale housing activity in 2006,” Klump added. (CREA 23/01/2006)
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