Investors are betting that the Bank of Canada will set the tone for the G7 to move to neutral rates


TORONTO, May 13 (Reuters) – As the Canadian economy overheats, the Bank of Canada is likely to be among the first of the major central banks to raise interest rates to a more normal level, even as concerns persist over to record levels of household debt. , say the strategists.

Money markets expect Canada’s central bank to continue raising rates by half a percentage point at its next two policy meetings, in June and July, after rising by that increase last month. , its largest increase in 22 years.

That would push rates up to the bottom of the 2-3% range that the central bank believes is a neutral metric, or the level at which monetary policy no longer stimulates the economy.

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The economy probably grew at an annualized rate of 5.6% in the first quarter. That’s well ahead of the Bank of Canada’s projections and compares with a contraction in the US and near no growth in the euro zone. Read more

“The Bank of Canada has the strongest case for already being neutral against any central bank in the peer group,” said Derek Holt, head of financial markets economics at Scotiabank.

The end of monetary stimulus could reduce the risk of inflation taking root in the economy. The move is probably more urgent with economic activity exceeding capacity.

Among the G7 central banks, the Federal Reserve and the Bank of England could also raise rates to neutral in the coming months. The Fed’s neutral estimate is in line with that of Canada’s central bank, but the BoE’s is much lower at 1.25% to 2.25%.

Unlike the Fed, Canada’s central bank does not have a dual mandate targeting employment and inflation, nor has it adopted average inflation targeting.

“There may be this perception, especially among international investors, that the Bank of Canada is maybe a little more proactive and less tolerant of high inflation,” said Jimmy Jean, chief economist at Desjardins Group.

Canada’s inflation rate hit a 31-year high of 6.7% in March, as jobs climbed well above pre-pandemic levels and the economy continues to benefit from a surge in commodity prices which was amplified by the war in Ukraine.

Government spending continues to drive the economy in Canada, while population growth increases demand for housing and other services, TD Economics strategists including Beata Caranci said in a note.

“This means the Bank of Canada may face a bigger challenge than the Federal Reserve in stifling the inflationary impulse,” the strategists said.

The Canadian economy will likely be particularly sensitive to higher rates after Canadians borrowed heavily during the pandemic to participate in a booming real estate market. Yet the BoC says the economy is strong enough to withstand further tightening.

All major central banks “face private debt and housing affordability issues, but if anyone can be neutral — and beyond — then it has to be the Bank of Canada,” said Holt of the Scotiabank.

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Reporting by Fergal Smith Editing by Nick Zieminski

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