The Bank of Canada could start raising interest rates as early as October, J.P. Morgan Chase & Co. said Wednesday, breaking with market consensus that borrowing costs are likely to stay on hold through to 2005.
The latest J.P. Morgan forecast suggests that the Bank of Canada — which has cut rates three times this year — will start moving in the opposite direction by the fourth quarter.
That would mean an interest rate increase either in the central bank's Oct. 19 fixed-date policy announcement or in its subsequent decision on Dec. 7.
A key factor in the forecast change, J.P. Morgan senior economist Ted Carmichael said, was this week's higher-than-expected reading on core inflation.
“Things tend to change fairly quickly sometimes,” Mr. Carmichael said. “We were definitely surprised by the inflation numbers that came out yesterday. “That's probably the biggest factor in my mind in pulling the call forward.”
Previously, the brokerage had predicted the bank's first move higher would come in the first quarter of 2005.
Although overall inflation held steady at an annual rate of 0.7 per cent in March, the core inflation rate — which excludes the eight most volatile components of the consumer price index — came in at a higher-than-expected 1.3 per cent.
Most economists now say inflation in this country has bottomed out and should start to rise in the months to come. The Bank of Canada expects inflation to average 1.5 per cent for the rest of this year, before moving back to 2 per cent by the end of 2005.
The central bank has a 1-to-3-per-cent target on inflation and likes to see the annual rate near the centre of that range.
Other factors suggesting an earlier move by the Bank of Canada include the growing likelihood that the U.S. Federal Reserve will start hiking rates south of the border this summer and an encouraging report Wednesday on Canada's future economic prospects.
In March, Canada's leading indicator composite index jumped by 0.7 per cent, more than double expectations. The index offers a indication of how the economy is likely to fare in the coming months. Statistics Canada also revised figures for December, January and February higher.
Mr. Carmichael said that means the three-month unsmoothed leading indicator rose at an annual rate of 8.6 per cent in March, up from 5.3 per cent a month earlier.
That advance, he said, is consistent with overall economic growth at an annual rate of 2.5 per cent in the first quarter, but likely a stronger 3-per-cent growth rate in the second quarter of the year.
Also playing a role in J.P. Morgan's advanced Bank of Canada call, he said, is the likelihood that the Fed will move in August.
“So we have the Fed going either in August and the Bank of Canada going either in October or December,” he said.
Speaking in Washington on Wednesday morning, Fed chairman Alan Greenspan told Congress interest rates in the United States will have to climb as the U.S. economic recovery maintains its momentum and early signs of increased price pressures are now being in some sectors.
“The federal funds rate must rise at some point to prevent pressures on price inflation from eventually emerging,” Mr. Greenspan said.
© The Globe and Mail
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