Interest rate hike unlikely as global recovery sputters

The Bank of Canada will almost certainly resist the easing trend that is sweeping policy makers in many developing and emerging economies this week, but its new economic projections may increase investors’ expectations of a rate cut before any hike.

Last week, central banks in South Korea, Brazil and Japan tinkered with borrowing costs to prop up flagging economies, joining their counterparts in Europe and Britain.

The Bank of Canada’s economic outlooks for Canada, the U.S., the euro zone and the world are bound to be gloomier than what they were three months ago.

For a vivid illustration of how uncertain and volatile things have been, recall that The last time Bank of Canada Governor Mark Carney and his officials took the economy’s temperature – in mid-April – the euro crisis looked to be stabilizing and the U.S. economy had come off a string of some of the best monthly employment gains in years.

Things seemed so much on the up-and-up that, with an improving domestic economy and a frothy housing market firmly in mind, Mr. Carney dropped his first hint since July, 2011, that interest-rate hikes were in the cards, and in the not-too-distant future. Yet, just like in 2011 (and 2010), a promising first half of the year gave way to another huge dose of gloom and dread.

As the central bank prepares to release its interest-rate decision on Tuesday and the quarterly Monetary Policy Report the next day, it’s conceivable the tone will hint at the possibility of lowering borrowing costs. Still, an interest-rate cut is less likely than policy makers simply keeping their benchmark interest rate at 1 per cent well into next year or beyond, as they grasp for signs that the global recovery is not at risk of going off the rails.

Mr. Carney in all likelihood will maintain his vague threat of rate hikes down the road unless he sees things worsen considerably in the coming weeks, economists said.

In April, the central bank said the economy would grow 2.4 per cent both this year and next, and that the remaining “slack” will be absorbed during the first half of next year. Well, that was then.

Mr. Carney last month acknowledged that his 2012 forecasts were not panning out. And reports over the past few weeks – including data on employment, trade and monthly economic growth – reinforce a view that in the first half of the year, the economy may not have grown at a 2-per-cent pace. Some analysts predict the economic slack won’t be absorbed until 2014, implying that the rate pause, already the longest since the 1950s, could last until then.

The U.S. recovery is increasingly listless. The ongoing debt crisis in Europe threatens to cause another global financial crisis and has pushed much of that continent into recession. Slowdowns in China and India are worsening, adding to fears that commodity prices could plunge later this year.

Optimism among Canadian executives is holding up, but is understandably a shadow of what it was a few months ago, as they worry about their ability to sell goods and services abroad amid weaker demand, and whether they’ll still be able to access funding if the euro crisis causes more shock waves in global markets.

Mr. Carney and his team will almost certainly downgrade their projections for the U.S. and the global economy. Of particular note will be their latest take on the effect that post-election fiscal belt-tightening in the U.S. could have on Canada. (In the Fed minutes, released last week, members of the policy committee surmised that U.S. fiscal policy “would be more contractionary than anticipated.” Not good, in an economy already struggling to gain traction.)

The all-important last paragraph: When the central bank wants to send a signal that its “bias” on rates has shifted in one direction or the other, it does so in one key sentence in the last paragraph of the statement. Given all of the above, it is possible that Mr. Carney will tone down a statement from his April and June decisions, in which he said rate hikes “may become appropriate.”

However, those statements also said that the “timing and degree” of any tightening would depend on how things play out in Canada and around the world, so he could easily leave that bit intact.

This would be a strong signal that he is still not even considering a reduction in rates. At the same time, the forecasts will probably make it pretty clear that he is in no rush to raise borrowing costs, either.

It is far less likely that he will abandon what economists call this “mild tightening bias,” even as the central bank cuts its growth and inflation forecasts. Indeed, the bank’s quarterly survey of Canadian companies, released last week, found more than half of those surveyed still planned to add staff over the next year, and there was a slight increase in the share of firms saying they might have trouble meeting a jump in demand.