By Nirmala Menon
OTTAWA--The spotlight will fall on the Bank of Canada's
inflation outlook when it issues its latest interest-rate decision
Wednesday.
A long spell of inflation of less than 2% prompted the central
bank to abandon long-standing signals of potential rate increases
last autumn and to adopt a neutral rate bias. But with consumer
prices trending higher, markets are watching its inflation
narrative closely, given that the central bank sets monetary policy
to achieve a 2% inflation target.
The trend in prices marks a significant change from the start of
the year, when the Canadian central bank and those in the U.S. and
other major economies were fretting about low inflation.
In Canada, the consumer-price index grew 2% year-over-year in
April and accelerated to 2.3% in May, the fastest pace in more than
two years. Both the headline and core inflation measures are
tracking higher than the central bank's forecasts in April, which
will make it harder to maintain the assertion from its June 4 rate
statement that downside risks to the inflation outlook are "as
important as before," economists said.
All 12 primary dealers of government securities surveyed by The
Wall Street Journal expect the Bank of Canada to hold its benchmark
interest rate at 1% on Wednesday, and through the end of the year.
The rate has stood at that low level since September 2010. The
unanimous view is that the next move will be a rate increase, with
projected time lines among economists ranging from the first
quarter of 2015 to early 2016.
A majority of economists expects the Bank of Canada to tweak its
language about the inflation outlook in Wednesday's statement to
reflect higher prices, but most say its view will be balanced by
growth concerns after Canada's gross domestic product fell short of
forecasts in the first quarter, growing just 1.2% in annualized
terms. And a dismal jobs report for June will bolster the central
bank's case that slack in the economy will keep the lid on
inflationary pressures, they said. The economy unexpectedly lost
9,400 jobs last month, and the jobless rate climbed to 7.1% from
7%.
The central bank will likely leave out the fact that the
Canadian dollar plays a major role in its characterization of the
inflation and growth outlook. The currency has firmed in recent
sessions, fueled partly by expectations of a less-dovish take on
inflation. But this could jeopardize the exports recovery that
Canadian policy makers hope will help drive growth as debt-ridden
consumers cut back on spending.
A weaker currency makes exports less expensive abroad and
therefore more competitive, so the Bank of Canada is likely to be
careful not to sound hawkish and risk the Canadian dollar taking
flight, observers said.
"The bottom line is, the Bank of Canada doesn't want to say
anything that would encourage a further rally in the Canadian
dollar. They will bend over backwards to maintain a neutral stance
as long as possible," according to CIBC World Markets chief
economist Avery Shenfeld.
But Stefane Marion, chief economist of National Bank of Canada,
believes the Canadian dollar has already priced in strong inflation
figures, so there is no risk of a major move if, as he expects, the
central bank tones down low inflation concerns and effectively
shifts to a tightening bias on rates.
"I don't think they will guide toward rate hikes, but it's an
overstretch to guide toward a rate cut," Mr. Marion said, adding
that the Bank of Canada will probably say that the overnight rate
will remain at 1% for an extended period.
Write to Nirmala Menon at nirmala.menon@wsj.com