Market takes rate hike in its stride

It’s the one we’d been holding our collective breath for. Close on the heels of its July announcement, the Bank of Canada (BoC) raised its benchmark policy rate a second time this summer, to 1%, but most Canadians are treating it as par for the course.

Experts in the financial industry assure that despite a second rate hike of 25 basis points, we are still in accommodative territory, as expectations of further rate hikes remain low.

The BoC is trying to stimulate the economy as a hedge against the weakening external events, says Stephen Lingard, co-lead manager of Franklin Templeton’s Quotential program. “I thought that the BoC would like to normalize interest rates to give them ammunition down the road, should we get into a situation where external growth is a little bit weaker, particularly as cited in some of Governor Mark Carney’s comments regarding external weakness.”

Clearly, the U.S. continues to be on shaky economic ground where throwing everything it could at the economy has only generated below 2% growth. This, says Lingard, means rates will need to remain low for quite a while yet. He’s hoping that the future rate hike will be on hold for this year and that, potentially, there will be some reversing of policy going into next year.

Jean Charbonneau, senior vice-president and portfolio manager, AGF Investments Inc., expressed similar sentiments. He expects no more hikes in overnight rates until the year-end. He says the BoC is following the “soft news” coming out of the U.S. closely. “The BoC is looking beyond our borders to see what the global recovery is doing and, given what’s going on in the U.S., they’ll most likely pause till the year-end.”

Lingard concedes that the Canadian economy cannot decouple from the U.S. economy. “Weakness in the U.S. [market] is going to continue to dictate that leading economic indicators of [our] economy have slowed.”

The pace of normalizing the monetary policy has, nonetheless, raised some eyebrows. “They will slow down the pace of renormalizing monetary policy,” says Charbonneau.

The prevailing sentiment seems to be that the BoC could be getting ahead of itself in normalizing its interest rate policies, considering that growth both at home and abroad has fallen far short of industry expectations and projections. “There’s a risk that the Bank would overdo it a bit,” says BMO Capital Markets deputy chief economist Doug Porter. “The bank seems to be more upbeat than others on the [economic] outlook, and it seems it’d take a lot for the Bank to stop raising interest rates.”

There’s little doubt that the Bank’s rhetoric would be that rates are still exceptionally low and that they are merely offsetting what the bond market is doing to financial conditions. Porter says there’s half a chance that the Bank will raise the rates again before the year is through.

Experts, however, expect the recent benchmark rate increase to have only a modest impact on the interests of advisors and investors. The rate hike is one of many variables that drive the broader financial markets, and the fact that the Bank is tightening things ever so slightly makes an event like this more of a sideshow in the larger scheme of things. “Today’s [rise in the] stock market is indicative [of the fact] that the gains in the U.S. and Europe really seem to be the bigger driver for the Canadian stocks,” says Porter.

An uptick of 25 basis points in the interest rates is not likely to have a material impact on investors or the economy, says Lingard, adding that the forward-looking statements are “much more dovish and accommodative than they certainly were in the spring.”

A stronger currency market today is yet another sign that the market was well prepared for the announcement and has fully digested the news.

(09/08/10)