Will Friday’s inflation report wipe out rate-hike expectations?

John Morrissy

OTTAWA — Expectations interest rates will rise in Canada this year could fade Friday as quickly as they rose this week, with an inflation report that’s expected to show the cost of living falling sharply in March, a leading economist says.
The Canadian dollar shot up this week after Bank of Canada governor Mark Carney raised his outlook for the economy in 2012 and said “some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.”
Market players are now factoring in a 90% likelihood the central bank will hike its key overnight lending rate by December by 25 basis points from the current 1%, where it has been since September 2010.

Yet, according to Scotia Capital economist Derek Holt, “no sooner than the ink is dry on the MPR (Bank of Canada’s Monetary Policy Report) will decelerating inflation into summer return inflation to the mid-point of the BoC’s 1% to 3% operating band or lower, and that should help put the too-quick-to-react elements within consensus who have brought forward rate-hike expectations back on their heels a bit.”
“Follow this up with differences of opinion on output gaps (or the rate at which the economy returns to full capacity) and it adds to our skepticism that any rate hikes will be delivered this year,” Holt added.
The bank uses interest rates to reached its target inflation rate of 2%. Market expectations are for the annual rise in the cost of living to fall to 2% in March from 2.6% in February when Statistics Canada releases the most recent data on Friday.
However, Michael Gregory at BMO Capital Markets said Friday’s inflation number will likely be consistent with Bank of Canada governor Mark Carney’s “somewhat firmer” 2012 inflation target of 2%.
“I don’t think it will change the market’s thinking that rate hikes are coming,” Gregory said.
The only difference is that much of a variation from the consensus target of 2% in Friday’s StatsCan report could slightly change the market’s mind as to when higher rates will arrive.
“What the bank is telling us is rooted in their worries about inflation — that current interest rates will allow inflation to drift above its 2% target in the medium term,” Gregory said.