Sharp, quick rate hikes needed: C.D. Howe

Last Updated: Tuesday, February 23, 2010 | 4:18 PM ET Comments42Recommend15

CBC News

The Bank of Canada should start hiking rates sharply, and soon, a new report by think tank C.D. Howe suggests.

In a report for the group, economist Michael Parkin argues that Canada's central bank should maintain its commitment to hold steady on rates until June, but then implement a 50 basis point hike at every six-week meeting starting in July and continuing through until mid-2011.

That would boost the key overnight lending rate from its current rock-bottom 0.25 per cent to 4.25 per cent by the middle of next year, assuming eight increases.

The Bank of Canada is set to release its latest decision on interest rates next Tuesday. The bank has repeatedly conditionally committed to keep rates at the current emergency low levels until the summer, barring any unexpected pick-up in inflation.

But the question remains how soon and how fast the central bank should tighten monetary policy after that.

In Parkin's view, the Bank of Canada will have to move aggressively.

"While the bank might want to raise the overnight rate more slowly than 50 basis points at every announcement date, doing so would keep the real overnight rate negative through a period in which the economy is returning to normal and run a serious risk of leading to excess demand and rising inflation expectations in 2012 and 2013," he wrote.

"Raising the overnight rate to slow the growth of the monetary base and the narrow monetary aggregates is crucial to holding the line on inflation as the recovery picks up steam in 2011 and beyond."

More guidance needed

The Bank of Canada has given no firm indication on when or how fast it's likely to move on the interest rate front. But whether or not it chooses to adopt an aggressive path, Parkin argues that the bank should provide more explicit guidance to "help shape market expectations and avoid surprises that disrupt financial markets, output, and employment."

Some observers have predicted the central bank will hold off on any rate hikes until 2011.

"Unless the bank wants to be pre-emptive — highly unlikely when it acknowledges in its economic outlook [in January] that 'the recovery continues to depend on exceptional monetary and fiscal stimulus' and that 'the overall risks to its inflation projection are tilted slightly to the downside' — then to raise rates before the middle part of 2011 would be totally inconsistent with its current forecast," Gluskin Sheff chief strategist Dave Rosenberg wrote in an op-ed piece in January.

Canada's annual inflation rate shot up half a percentage point to 1.9 per cent in January, the largest increase in more than a year, Statistics Canada reported last week. Core inflation rose to two per cent.

The Bank of Canada said in January it expects the country's economy to grow by 2.9 per cent this year and 3.5 per cent in 2011.