* BoC holds rate at 1 pct, same level since Sept 2010
* Says may need to withdraw stimulus
* Sees firmer growth, inflation; faster return to capacity
* C$, bond yields jump on news, markets see earlier hikes
By Louise Egan and Randall Palmer
OTTAWA, April 17 The Bank of Canada said on
Tuesday it may need to start raising interest rates, preparing
to lead the Group of Seven industrialized nations in lifting
borrowing costs even as fears of a flare-up of the European debt
crisis have not fully faded.
The central bank held its key overnight rate at 1 percent as
anticipated but issued a surprisingly hawkish statement that
included explicit language on eventual rate increases for the
first time since last July.
"In light of the reduced slack in the economy and firmer
underlying inflation, some modest withdrawal of the present
considerable monetary policy stimulus may become appropriate,
consistent with achieving the 2 percent inflation target over
the medium term," the central bank said in a statement.
The language caught traders off guard, with Canadian dollar
and rate futures both jumping following the statement.
The central bank described an economy that is at a turning
point where inflationary pressures could become a concern and
high household debt is the biggest risk.
It raised its growth and inflation forecasts for this year
and said the economy will return to full capacity - the limit at
which it can grow without generating excessive inflation - in
the first half of 2013 rather than in the third quarter as it
predicted in January.
The news prompted three of nine primary dealers surveyed by
Reuters on Tuesday to pull forward their forecasts for a rate
hike. [C A/POLL]
The median forecast is now for a hike in the first quarter
of next year whereas a similar poll last month called for a hike
in the third quarter. Five dealers have now pulled forward rate
hike forecasts since that poll.
"Certainly it's a more hawkish statement than the market was
anticipating," said Sal Guatieri, senior economist at BMO
"So we could see a rate increase this year - at least a
couple of taps on the monetary brakes are possible," he said.
The Bank of Canada has frozen rates since September 2010
after it became the first in the G7 to raise borrowing costs
from lows hit during the financial crisis.
It had a false start in mid-2011 when it signaled intentions
to increase rates, but it had retreated by September as the
European debt crisis exploded.
Its language in Tuesday's statement was more tentative than
in July 2011 when the bank said stimulus "will" be withdrawn.
Canada's economy has grown steadily since emerging from the
2008-09 recession but policy makers had warned the recovery was
at risk from the European debt crisis.
Those external headwinds have abated somewhat, the bank
said on Tuesday, although Spain and Italy have come under market
pressure this week in a reminder the crisis is not over.
The outlook, which will be discussed in detail in its
quarterly Monetary Policy Report on Wednesday, formalizes the
more bullish tone adopted by Bank of Canada Governor Mark Carney
in the past month.
"In sum, we view this communiqué as an important, and large,
step towards further normalizing the overnight rate," said David
Tulk, chief macro strategist at TD Securities.
AHEAD OF FED
Such a move would put Canada well ahead of the U.S. Federal
Reserve, which has said it expects its key rate to remain near
zero until at least late 2014. The European Central Bank
likewise has not discussed rate changes, ECB President Mario
Draghi said this month.
Tulk now sees the earliest possible date for a hike as
September, though he says it is more likely to come later.
On the more hawkish end of the spectrum, Nomura Global
Economics analyst Charles St-Arnaud sees a hike as early as the
bank's next rate announcement on June 5.
The Canadian dollar strengthened after the release
of the bank statement, rising to a near one-month high at
C$0.9865 versus the U.S. dollar, or $1.0137, from C$0.9958 to
the U.S. dollar, or $1.0042, before the statement.
Overnight index swaps, which trade based on expectations for
the central bank's key policy rate, showed that after the
statement traders priced in higher odds of a rate hike later
this year but see little chance of one at the next meeting in
The yield rose on the two-year Canadian government bond
, and government bond prices underperformed U.S.
Treasuries after the news, especially shorter term issues.
The bank said on Tuesday that economic growth and inflation
are both likely to have more momentum than it forecast in its
January Monetary Policy Report.
It revised its 2012 growth projection to 2.4 percent from 2
percent in January, but cut its 2013 projection to 2.4 percent
from 2.8 percent. It sees growth moderating to 2.2 percent in
That was more upbeat than the International Monetary Fund's
World Economic Outlook, which on Tuesday forecast 2 percent
growth this year.
The bank said inflation will soften in the second quarter
but then will rise to the bank's 2 percent target "for the
balance of the projection horizon". In January it saw inflation
reaching 2 percent in the third quarter of 2013.