OTTAWA — The Bank of Canada has yet to officially start hiking interests rates, but already Canadians are feeling the impact of higher borrowing costs.
Analysts say expectations the central bank will boost rates June 1 at the earliest and July 20 at the latest have boosted the Canadian loonie and pushed the big banks to twice raise mortgage rates in the past two weeks.
The loonie has been steadily gaining ground for weeks and Wednesday closed above parity, at 100.08 cents U.S., for the first time in almost two years.But economists warn there is danger in the Bank of Canada moving ahead of the U.S. Federal Reserve on hiking rates, even if it is justified by the fundamentals.
“The Bank of Canada is basically going to fly solo,” said Benjamin Tal, an economist with CIBC World Markets.“The markets are already discounting 75, maybe 100 basis points and it’s already in the price of the dollar.”
Canada’s economy has sprinted forward following last year’s recession to record a five per cent advance in the fourth quarter of 2009, and expectations are the first quarter will show an even quicker pace.
More importantly, Canada has recouped nearly half of the total job losses of the downturn, while the United States still struggles with the disappearance of 8.5 million jobs, a decimated housing market and a financial sector still hobbled by an excessive overhang of debt.
In testimony to Congress on Wednesday, Fed chair Ben Bernanke suggested it will be some time before the U.S. starts raising the policy rate from the current near-zero emergency stance.
“The Federal Open Market Committee has stated clearly that they currently anticipate that very low, extremely low rates will be needed for an extended period,” Bernanke told a Congressional committee.
Economists say moving ahead of the U.S. — which is all but certain — could have some beneficial effects, such as cooling what many believe is an overheated housing market by making mortgage costs higher.
But the bigger problem is that higher rates attract more foreign capital into Canada and gives an additional lift to the loonie, something few, except for possibly cross-border shoppers, want.
Finance Minister Jim Flaherty said Wednesday that the strong loonie is a reflection of the relative strength of the Canadian and U.S. economies.
While true, said Liberal critic John McCallum, a former bank economist, there is a risk in raising rates while the U.S. keeps theirs low.
“Then our dollar could get even stronger and that would be really bad for exports and jobs,” he said.
While some analysts have speculated that Canada’s manufacturing sector is no longer as exposed by a strong currency as a decade ago, few disagree with the notion that currency appreciation is a net negative for the economy.
This week’s trade numbers showed the rebound is almost all due to energy, while the goods side registered a $4.4 billion deficit in February.
Carl Weinberg of U.S.-based High Frequency Economists was not impressed.
“You might think that the largest supplier of crude oil to the United States would be able to run a bigger surplus,” said Weinberg. “Blame the strong loonie for a lot of the woes of exporters, especially since so much of what Canada sells is priced in U.S. dollars.”
Given the signals the bank has sent, it would take a major reversal in the recent spate of good economic news, as well as easing inflationary pressures, to stay the central bank’s hand on rates.
However, Sheryl King, chief economist with Merrill Lynch in Canada, says she does not believe governor Mark Carney will get too ahead of the curve and will keep the increases modest.
She says the economy may be hot now, but she sees it cooling in the second half of the year, and Carney putting on his brakes until the Fed shows signs of joining him on the policy tightening track.