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Should you lock in today?
Wednesday, March 10th, 2010OTTAWA — With Bay Street convinced the Bank of Canada will maintain its pledge to wait until July to begin raising interest rates, the debate now turns to how aggressively the central bank should behave thereafter.
In the view of a paper prepared for the C.D. Howe Institute, the central bank should act with zeal. If it wants to get ahead of the inflation curve, the bank should raise its benchmark rate by 50 basis points at every scheduled rate announcement until the middle of next year, the paper said.
Michael Parkin, an economics professor at the University of Western Ontario and member of the think-tank’s monetary policy council, said “steep” increases would be required to make up for keeping the benchmark rate so low for so long.
The paper comes a week before the Bank of Canada’s next interest-rate statement, scheduled for March 2 and the same day Mark Carney, the bank governor, held an annual meeting with leading private-sector economists in Ottawa.
The bank cut its benchmark rate last year to a record low 0.25%, and made a pledge — conditional on inflation — to keep it there until the end of June in an effort to pump up the economy amid the financial crisis. Analysts say the move has worked. Figures on gross domestic product, to be reported next week, should indicate the economy grew roughly 4% in the fourth quarter, above the central bank’s own expectations. And inflation is closer to the bank’s 2% target earlier than envisaged, although analysts suggest price increases could lose some steam in the weeks ahead.
The main thrust of Mr. Parkin’s argument is the central bank needs to raise rates as aggressively in anticipation of the recovery as cut in response to the financial crisis. This would be in line with the Taylor rule, which dictates by how much a central bank should move its benchmark rate in response to inflation.
Based on the central bank’s own economic projections, Mr. Parkin calculated the future path of interest rates. “When the [benchmark] rate starts to rise, it must be on a steep upward path,” he wrote. Under the Taylor rule the benchmark rate should in fact, be higher than present levels. As a result, a target rate “somewhat higher” than what otherwise would be required might be necessary for the latter half of this year and all of next, he said, “to avoid inflation running above target.”
Economists indicate the central bank, if possible, will keep its pledge because reversing course now could damage its credibility.
Other analysts also signalled that they shared some of Mr. Parkin’s view.
“In order to move from an exceptionally low to low-rate environment, you need to move fast,” said Sébastien Lavoie, economist at Laurentian Bank Securities, which last fall indicated in a report Mr. Carney would need to entertain rate increases of up to a percentage point.
Michael Gregory, senior economist at BMO Capital Markets, said that by mid-2011 the benchmark rate would “have to be in proximity of being neutral.”
However, he added the central bank would have to take into account the strength of the loonie in determining the appropriate level of interest rates. The currency is likely to climb as the Bank of Canada moves ahead of the U.S. Federal Reserve, and perhaps more aggressively, Mr. Gregory said.
Financial Post
(Feb 24, 2010)
