Posted by: Daryl & Wendy Ashby | March 18, 2010

Where are Interest Rates Going?

Diana Petramala, Economist for TD Bank Financial answers that question:

I think there are three main questions here, and I will try to provide the best answers I can to each.  

1)       When do we see the Bank of Canada moving?  

While the Bank of Canada has committed to  keeping rates low until July, we think that the significant amount of slack in the Canadian economy, coupled with our belief that a slower recovery than they are anticipated will play, will keep them on hold past their conditional commitment.  We don’t see the first rate hike coming until the fourth quarter of 2010 – about a quarter ahead of the Fed.

2)       If the Bank of Canada moves ahead of the Fed, would the loonie go to parity? 

The answer to this question is yes.  This is in fact inherent in our exchange rate forecast. With the Bank tightening ahead of the Fed, and interest rate differentials tilting in favour of the Canadian dollar, we expect the Canadian dollar will rise to slightly above parity by year end.

 3)       Is it likely that the Bank of Canada move ahead of the Fed? 

The answer to this question is a two part yes.  

First, each central bank should react to its own economy’s circumstance. Canada’s economic fundamentals remain much stronger than in the U.S., and the recession was not as bad here in Canada, and as such the amount of slack in the Canadian economy was not as large as it is the U.S. 

We think that by the end of 2010, strength in Canada’s domestic demand will mean that the slack will start to be eaten up, and will start to exert some upward pressure on inflation, despite any weakness that may be coming from trade. 

Second, while the Fed will keep rates low until the beginning of 2011, that doesn’t mean that they will not start tightening policy sooner (unrelated to interest rates hikes).  With quantitative easing, monetary policy is much more stimulative in the U.S. than it is in Canada, and the Fed will want to start reigning in some of the extraordinary measures before raising interest rates.  In fact, they have stated that they want to begin raising reserves. 

So, even though interest rates will remain at their current level until the beginning of 2011, tightening may begin ahead of the Bank of Canada’s first move.

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