Canada’s Key Lending Rates Rise

I’m buying a new home, so I was very much tuned into yesterday’s announcement by the Bank of Canada. As was expected, the central bank has raised its overnight lending rate by another 25 basis points, from 3.75% to four percent.

Note that this is the sixth consecutive time the rate has gone up since September, and more of such moderately paced increments are likely to follow in the near-term. Well, it’s just my luck, since I prefer the variable rate over the fixed rate on my mortgage. But, I shouldn’t complain. With prime sitting at 5.5% at the moment, Canadians are still operating in an ultra-low interest environment.

Unlike the Federal Reserve, which is raising interest rates to prepare the economy for a softer landing, the Bank of Canada is raising rates fearing inflation. Canadian economy is widely expected to continue operating full steam ahead.

In fact, in yesterday’s announcement, the central bank said that the country is operating at, or slightly above, its overall production capacities. So, in order to keep that ever-so-tender balance between supply and demand in check, as well as to tame inflation, more rate increases are forthcoming down the road.

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There was one more thing in yesterday’s announcement. For the first time since September, the Bank of Canada specified that it will base its future rate decisions on specific developments with the economy. This suggests that the central bank is fearful of explosive growth, which could trigger inflation.

In case anyone is wondering where all this growth is coming from, just look at Canadian companies engaged in mining, oil and gas exploration, and construction. These guys are just smokin’!

According to the bank’s conservative estimate, Canadian economy is expected to grow about 3.1% by the end of 2006. The estimates for 2007 and 2008 sit at three percent and 2.9% respectively.

Not surprisingly, the Canadian dollar also shot up after the announcement to $0.8831 versus the greenback. Admittedly, along with cutthroat global competition, the strong Canadian dollar is becoming more and more of a problem to a number of sectors.

At the root of the latest string of rate increases are, of course, high energy prices. The central bank is a bit uncomfortable having the consumer price inflation tipping over the two percent target. Canadians, unlike Americans, pay more attention to this expanded inflation gauge, rather than the core inflation, which excludes energy costs. (Note that core inflation remained under two percent, mostly because of cheaper imports.)

Now that Tuesday’s interest rate hike is behind us, I’m looking forward to a more detailed report on Canada’s monetary policy, which is due tomorrow, since this report is likely to set the tone for the economy for the remainder of the year.