On July 16, the Bank of Canada hiked its overnight bank rate by a quarter point, to 2.75%. It was the third hike since April, even as the Federal Reserve is holding its target rate steady.
While the BOC does not always move in lockstep with the Fed, this is the first time since 1998 that the Canadian rate is a full percentage point higher than the U.S. federal funds rate. Back then, a jump in unit labor costs raised Canadian inflation worries.
Now, the fear is that the economy is growing so fast it will be at full capacity by early 2003 and thus vulnerable to rising price pressures. That was the explanation in the July 24 update of the BOC's Monetary Policy Report. In June, the yearly core inflation rate was 2.1%, right in the middle of the BOC's target range of 1% to 3%.
The Canadian economy is already showing signs of slowing, after a 6% annual rate surge in the first quarter. In May, both retail sales and wholesale shipments fell. And the trade surplus narrowed because of a drop in May exports. Nonetheless, real gross domestic product probably grew at an annual rate in excess of 4% in the second quarter, at least twice the expected U.S. advance.
Real GDP is projected to grow 3% to 3.5% in the second half. That pace is strong enough to reduce the unemployment rate from 7.5% in June and to keep industrial production growing. However, expectations for a slower economy clobbered the Canadian dollar on July 22 and 23. It suffered its worst two-day loss ever. A weaker currency will keep an upward pressure on prices in the months ahead, even as growth eases.
So while the BOC's latest report suggests the bank prefers to sit on the sidelines for a while, the expected tightening in the labor markets and industrial capacity means policymakers won't be able to delay another rate hike for very long. By James C. Cooper & Kathleen Madigan