Today, the Bank of Canada announced that it is raising its overnight rate by a quarter point from 0.75% to 1.00%. This will impact the Prime lending rates of the Banks; Prime will increase from 2.75% to 3.00%.

The Bank now expects the economic recovery in Canada to be slightly more gradual that what they had previously anticipated in July primarily due to a lack-lustred economic recovery in the United States due to high unemployment. In Canada, the Bank of Canada expects consumption growth remaining solid and business investment to rise strongly due to accommodative credit conditions. Quite interesting especially when we saw, yesterday, that gold hit an all-time high (currently $1,260 per ounce) due to renewed fears surfacing about European Banks. Inflation is still in line with the Bank’s expectations (and this is always good news).

Most economic commentators are of the opinion that the Bank of Canada will not increase the overnight rate for some time now. Time will tell and the next scheduled announcement is October 19, 2010.

The Bank of Canada raised its benchmark interest rate by 0.25% – this is the first increase since 2007 – saying inflation is unfolding as expected and that spillover from the European debt crisis has been limited, while stressing there remains “considerable uncertainty” about an “increasingly uneven” global recovery.

In a statement on the move, Mr. Carney and his rate-setting panel sought to emphasize that investors should not necessarily interpret the increase as the first in an uninterrupted series.

The Canadian economy, which on Monday posted a whopping 6.1-per-cent annualized growth rate for the first quarter – the fastest in more than a decade – is “unfolding largely as expected,’’ the bank said, led mostly by a hot housing market, higher incomes and a labour-market recovery that have helped fuel consumer spending.

Still, the central bank suggested that household spending and the economy will slow in the coming months as consumers deal with higher borrowing costs and try to limit or reduce their debt loads and as government stimulus spending fades. As a result, an “anticipated pickup in business investment will be important for a more balanced recovery,’’ the bank said.

Inflation, which the central bank has been watching closely for months, has been in line with policy makers’ projections to exceed 2 per cent this year and reflects a combination of strong domestic demand, slowing wage increases and “excess supply’’ leftover from the recession.

Given today’s rate increase look to the bond market yields increasing over the short term i.e. fixed rates will invariably increase.

The next scheduled date for announcing the overnight rate target is 20 July 2010.

Paul Vieira, Financial Post

Ottawa — Bank of Canada governor Mark Carney has had a busy time of it since taking over as the country’s central banker 27 months ago, mostly tackling the financial crisis, mapping out the road to recovery and reassuring Canadians that at the end of the day the bank’s extraordinary policies would work.

The one thing he has yet to do during his term, however, is raise interest rates. That might be about to change on Tuesday. If he does pull the trigger – and that is what most analysts expect – it won’t be after grappling with competing forces that convey two starkly different messages about the economic outlook.

“We are at point where it is a tug of war between structural issues that are facing the eurozone and a very strong economic cyclical backdrop,” says Stéfane Marion, chief economist at National Bank Financial.

Weighing on the governor are the economic data, which call out for a rate hike – as much as 50 basis points, some reckon. The data have been consistently strong and surprising to the upside. Job creation is in full swing, with a record 109,000 workers added to payrolls in April; consumers are buying up goods at a healthy pace, tax credits or not; corporate profits are rebounding to pre-recession levels; and inflation is creeping closer to the central bank’s preferred 2% target. The sterling fundamentals prompted the central bank last month to ditch its conditional commitment to keep its policy rate at a record low 0.25% until July, leading traders to price in a nearly 100% chance of a rate hike on June 1.

That was until sovereign debt worries exploded in Europe, once Greece formally asked for international help days after the last Bank of Canada rate decision. That sparked an across-the-board retreat in global equity markets, down 9.3% since the beginning of May, as traders sold stocks and poured into risk-averse U.S. treasuries and other government securities on fears that another credit crunch was at hand. Mr. Carney is likely aware of this better than most, given his capital markets background from Goldman Sachs.

The most worrying sign on Mr. Carney’s radar screen might be the small but steady increases in the cost of borrowing among banks, a signal European lenders are finding it tough to access cash from their peers on concern over how much Greek, Portuguese and Spanish debt they hold.

In the end, the consensus is Mr. Carney is leaning toward a rate hike – a modest one, though, of 25 basis points. The thinking is, an ounce of prevention now is worth a pound of cure later.

“We can’t look at things in a vacuum, because there are so many other factors besides Europe’s issues” says Jonathan Basile, an economist with Credit Suisse in New York who closely watches Canadian markets. “The truth is the macroeconomic evidence is outweighing the financial risks right now.”

The last time the Bank of Canada raised its benchmark rate was in July 2007, by 25 basis points to 4.5%. At the time, former governor David Dodge said the economy was operating above its production potential, and inflation was likely to stay above its 2% inflation target for longer than forecast.

Little did Mr. Dodge know that the U.S. subprime crisis would morph into the worst financial crisis since the Great Depression, roiling markets and economies around the world. This is why Europe’s recent fiscal woes have triggered a case of nerves, and might prompt Mr. Carney to rethink any rate move.

“The Bank of Canada wants to raise rates, but it doesn’t have a crystal ball,” CIBC World Markets said in a note to clients. “It can’t be certain that the recent financial market downturn isn’t going to morph into something more severe that would make a rate hike look out of place.”

There’s another school of thought, though, that suggests markets have overreacted to a regional problem. In this context, it is key to remember the Bank of Canada didn’t expect the eurozone to contribute much to global growth, envisaging only 1.2% expansion this year and 1.6% in 2011.

“The European picture will calm down and people will realize it is not as dramatic as being played out,” says Carlos Leitao, chief economist at Laurentian Bank Securities.

Yes, he acknowledges, the debt-ridden southern European economies have tough years ahead. But other countries, led by Germany and France, are going to capitalize on the lower euro and boost their exports to emerging economies and North America, which will help offset the drag from the so-called Club Med nations.

Besides Europe, Mr. Carney has other factors to consider.

Canada’s sovereign debt levels are indeed much better than the industrialized world, as our politicians like to remind us. But the amount of debt held by households, measured as a percentage of disposable income, stood at a historical high of 146% – of which 98% is mortgage related – at the end of 2009, rating agency DBRS estimates. That would put Canadian households ahead of the United States but behind Britain on this measure. A rate hike would signal it might be time to live more modestly and refrain from too much debt-financed consumption (which helped fuel those nasty asset bubbles that central banks may want to pay more attention to in the aftermath of the subprime debacle).

Mr. Carney’s other challenge is to explain why, and what’s ahead. He has come off a period where he provided extraordinary guidance to markets. Don’t expect similar language from the governor.

If anything, Mr. Marion warns the central bank should refrain from using the type of guidance the U.S. Federal Reserve deployed in 2004, when it signalled a period of “moderate” rate hikes were in the offing.

In retrospect, the Fed’s use of the word moderate “encouraged more financial excesses,” leading to the subprime bust, Mr. Marion says. “Carney doesn’t have to be brusque about it. He has the luxury to start slowly, and leave his options open,” from pausing should Europe deteriorate to hiking aggressively, by 50 basis points, if conditions warrant.

Mr. Carney reminded us recently that “nothing is pre-ordained” at the Bank of Canada. He’s likely to drive home that point on Tuesday, rate hike or not.

Tavia Grant

Globe and Mail Update Published on Sunday, May. 30, 2010 8:10PM EDT Last updated on Monday, May. 31, 2010 7:07AM EDT

Nearing one of the biggest decisions of his tenure as Governor of the Bank of Canada on Tuesday, Mark Carney will be equipped with a mountain of information on the latest economic trends, produced by the central bank’s small army of economists and researchers. He will have huddled closely with his top lieutenants, discussing the state of financial markets and key factors affecting the economy, such as the housing sector or Europe’s current fiscal woes.

But for all the deliberate information gathering and shared input at the central bank, Mr. Carney wastes no time as he calls the shots, say those who have worked with him.

“As an academic, I found it a bit difficult to keep comments to just three minutes,” says Angelo Melino, a University of Toronto professor who was the bank’s special adviser in 2008 and 2009, through the chaos of the financial crisis. “[Mr. Carney] is very business-like and quick moving. He would no doubt listen, but was very willing to challenge you as well. If you said something that didn’t quite fit together, or fit with his views, he’d have no qualms about responding. He was very much in control.”

Eight times a year, the Bank of Canada issues a decision to hold, raise or cut interest rates it charges for short-term loans to banks. The decision is a product of intensive research and collaboration at the bank’s Ottawa headquarters at 234 Wellington St.

Rate-related discussions ramp up on the Wednesday before the announcement. The governing council, now comprised of Mr. Carney and deputy governors Jean Boivin, Pierre Duguay, John Murray and Timothy Lane, is briefed on four major topics: risks and the likely path for the economy; the bank’s business outlook survey and regional views; credit and money conditions; and market expectations on interest rates.

Research has been assembled by some of the bank’s 200 economists and address every aspect of the economy – from GDP reports to car sales, housing starts, employment, trade and retail sales. Bank staff crunches numbers on how alternative scenarios – higher rates, tighter credit or rising oil prices – would play out. Temporary factors are considered, like strikes, weird weather or special car promotions.

Backgrounders are distributed on dozens of issues: whether Canada’s housing market is overvalued, inventory cycles in China, oil forecasts or U.S. auto sales, to mention a few.

“An enormous amount of effort goes into where we are – trying to figure out what’s going on in the economy because of the lags in the information they receive,” Mr. Melino says. “That’s something the bank wants to do better. During normal times it’s not that important but during a crisis, Christ, finding out where you are is really, really important.”

On Friday morning, over coffee, water or juice in the bank’s board room, the council meets with the monetary policy review committee, which includes six special advisers, chiefs of four economics departments, communications officials and financial markets directors in Montreal and Toronto. Up to 22 people attend, BoC spokeswoman Stephanie Bento says.

The meeting lasts about an hour and a half. They discuss any recent developments in financial markets or the global economy, changes in the labour and real-estate market. They talk about the market, and how it might react to various decisions. They discuss how key messages should be communicated.

Then each person in the room airs his or her views and makes a recommendation on interest rate strategy.

Mr. Carney, 45, landed as Governor in 2008. Since then, a string of long-tenured deputies such as Paul Jenkins, David Longworth, Sheryl Kennedy have left. At the end of July, Pierre Duguay will do likewise. A younger guard, including Tiff Macklem who rejoins the bank as senior deputy governor on July 1, has taken the reins.

By all accounts, it’s a place where Mr. Carney is top dog. His tenure has been marked by increased transparency – the bank now publishes four full-blown monetary policy reports a year, for example – and with that also comes heavier workloads.

The bank has also boosted scrutiny in several areas in recent years, such as risk management and global developments.

Europe will be a key focus this time round, says Sheryl King, who was an economist at the central bank for eight years and is now head of economics at Merrill Lynch Canada.

“They’re going to be looking at possible channels of contagion. Is Europe going to be weaker? Are banks safe, are they liquid? The issue becomes if it’s not contained there, does it spread elsewhere? Everyone’s thinking back to 2008 … those are the types of things they’ll be taking into consideration.”

She describes the tone of these briefings as “cordial,” where people are deferential to the chain of command. Though she left the bank before Mr. Carney’s arrival, her sense is “the Governor’s view is the dominant one, and there’s little dissent once he airs it.”