Higher interest rates on way, Carney warns

March 25, 2010

Les Whittington

Bank of Canada Governor Mark Carney prepares to testify before the Commons finance
committee on Parliament Hill in Ottawa. (Oct. 27, 2009)

CHRIS WATTIE/REUTERS

OTTAWA–Bank of Canada Governor Mark Carney has put Canadians on notice that
today's rock-bottom borrowing costs are likely headed upwards by midsummer – if not
sooner.

He acknowledged Wednesday that inflation and economic growth are rebounding faster
than the bank predicted and left the door open for a rise in the central bank's trend-setting
overnight rate more quickly than Canadians have expected.

Nearly a year ago, Carney decided to combat the recession by taking the unusual step of
promising to keep the bank's overnight rate at a record low 0.25 per cent until the end of
this June.

But, in a reminder that he has the option to hike rates sooner, he drove home the point on
Wednesday that he has always said the bank would re-examine its stance if inflation – its
main concern – threatened to get out of control.

The commitment to rock-bottom interest rates "is expressly conditional on the outlook for
inflation," he reiterated in a speech to the Ottawa Economics Association.

"The bank has an unwavering commitment to price stability," Carney said.

"That means keeping inflation low, stable and predictable," he added.

Rising Bank of Canada rates cause commercial banks to follow suit, driving up borrowing
costs for consumers, homebuyers and business. This slows economic expansion and cools
inflation, but it is not without risks. Raising rates too quickly could slow Canada's rebound
from the recession.
Economic growth and price increases have both exceeded expectations in recent months.
The core inflation rate, which excludes volatile items such as gasoline, rose to 2.1 per cent
in February, Statistics Canada said last week.

This is considerably more than had been predicted by Carney, who forecast that core
inflation would average 1.6 per cent in the January-through-March period and not hit 2 per
cent until the second half of this year. The bank's long-term goal is to head off runaway
inflation, which it tries to do by manipulating interest-rate policy to keep price increases in
the 2 per cent range.

With inflation rising, analysts have speculated that the bank might not wait until mid-year to
raise interest rates.

But Carney was careful not to tip his hand, saying Canadians will have to wait until the
bank's next interest-rate setting on April 20 for a decision. As for a reading of inflation
dangers, the bank will publish its analysis in its quarterly report on April 22.

In the meantime, he warned Canadians that sooner or later interest rates will be rising now
that the economy is recovering from the recession.

"We're not trying to give personal financial advice," he said at a news conference. But
"certainly in any sort of major purchase or financing that individuals are considering, (they
should) recognize that interest rates are at extraordinarily low levels" and will be going up,
Carney said. Canadians should "think about your ability to service your debts if rates move
to a more normal level."

While acknowledging inflation is "slightly firmer" than the bank forecast and economic
expansion in the early months of this year is stronger than expected, Carney was guarded
in his assessment of the outlook.

He pointed out that Canadians are dealing with "an economy that is just emerging from a
very deep recession."

And he noted that the sharp rise in inflation in February may reflect a one-time phenomenon
– the rise in accommodation costs during the Vancouver Winter Olympics.

Still, the fact Carney is not hinting at any changes to his year-old promise to hold the bank's
overnight rate at 0.25 per cent until the end of June is an indication borrowing costs will
likely be going up at mid-year, said CIBC World Markets economist Avery Shenfeld.
"By saying nothing about what happens after June, it starts to become a hint that rates will
move up in July."

But it will be a tricky call for Carney because pushing up rates could strangle the economic
rebound and drive up the value of the loonie on exchange markets, hurting the ability of
exporters to sell goods in the key United States market.

"We're still in the relatively early stages of a recovery, and I think the bank probably should
err on the side of trying to stimulate the economy," said United Steelworkers economist Erin
Weir.

"The other big risk of raising interest rates too soon is that it could drive the Canadian dollar
even higher, which of course would hurt export industries and could staunch the recovery."