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Why the Bank of Canada could be among the first to raise interest rates

The head of currencies at one of the world’s largest banks is partially responsible for the Canadian dollar’s appreciation over the past few months.

Paris-based BNP Paribas SA’s currency portfolio is “overweight” loonies and Momtchil Pojarliev is advising the bank’s clients to do the same. He reckons the Canadian dollar is undervalued since the petro currency’s price hasn’t fully adjusted to the likelihood of stronger oil prices as the global economy recovers from the pandemic.

Pojarliev also thinks the Bank of Canada will be one of the first major central banks to raise interest rates, because stronger commodity prices and decent economic growth will force governor Tiff Macklem and his deputies to confront inflationary pressures sooner than most of their peers.

To be sure, these are future considerations. There won’t be any talk of higher interest rates when the Bank of Canada’s leaders conclude their latest round of policy deliberations on Jan. 20. The most pressing concerns for the central bank at this stage are whether a grim winter will cripple the recovery, and when to slow its multi-billion-dollar bond-purchase program, which could create asset-price bubbles if left in place too long.

Stephen Poloz, the previous governor, on Jan. 14 said he anticipates a “double-dip” recession, meaning he assumes the lockdowns that have followed the second wave of COVID-19 infections will trigger a second economic contraction, albeit not as epic as what occurred last spring.

“We’re off to a rough start for the new year,” Poloz said over video during an event hosted by Western University’s Ivey Business School. “The economy is very likely to form a ‘W,’ economists’ parlance for the double-dip, although the second half of the W may not be as significant as the first half was given what we’ve learned in the interim.”

Macklem in December acknowledged that things could get tougher in the short term, with the central bank anticipating a “choppy trajectory” until a critical mass of the population is vaccinated. That’s the main reason he promised in October to leave the benchmark interest rate pinned near zero until some time in 2023, a pledge he will likely reiterate this week.

The governor and his deputies will probably decide there is enough stimulus in place to power through whatever winter brings. Vaccines have arrived sooner than the central bank expected they would in the fall, suggesting the outlook for 2021 has improved.

Jean-François Perrault, chief economist at the Bank of Nova Scotia, earlier this month predicted that Canada’s gross domestic product will decline at an annual rate of 2.1 percent in the first quarter, and then rebound at rates of 7.9 percent and 7.3 percent in the second and third quarters, respectively.

The Bank of Canada is scheduled to complete its own policy review by the end of the year. Adding an employment target is on the table, as is an approach called “average-inflation targeting,” which would give policy-makers more flexibility to tolerate faster price increases. That’s how the Fed does it, and few think it will be raising rates in early 2023. If Canada changes its monetary policy regime, the Bank of Canada probably won’t be either.

References: Financial Post

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