Although higher interest rates are expected from the Bank of Canada in the near future, due to  the strength of the Canadian economy over the past six months, a new report from CIBC’s chief economist Avery Shenfeld, suggests that rates are instead  likely to remain at a very low 2.5 per cent through to 2011, as opposed to the seven to eight per cent forecast by some analysts.

In CIBC World Markets’ latest Global Positioning Strategy report, Shenfeld lists several reasons for Bank of Canada Governor Mark Carney to keep interest rates subdued after July. He points out that the U.S. will probably have a more gradual approach to raising rates and if Canada gets too far ahead, that could send the Canadian dollar soaring.

The factors he sees supporting a more measured pace on rate hikes after the summer include the following:

-   The long path to sustained growth south of the border means an
interest rate hike there is likely several quarters away. “Why should
Governor Carney care about getting too far ahead of the U.S. Federal
Reserve (in raising interest rates)? Because when the Fed is still on
hold, it reflects Washington’s judgement that a self-sustaining
rebound isn’t yet assured,” says Mr. Shenfeld.

-   Unmatched rate increases in the U.S. could also “send the Canadian
dollar into record territory,” he adds. “While factories are
recovering in Canada alongside a global industrial revival, output
remains nearly 20% below the pre-recession peak, and wages are now
substantially above those stateside without the productivity gains to
match. There’s only so much of a competitive challenge that non-
resource exporters can take in short order.”

-   The recent uptick in inflation is not expected to continue as
Canadian production is below its potential. This “output gap” serves
to restrain wages and other costs, ultimately reducing the need to
hike rates to curb inflation.

-   Federal and provincial belt tightening beginning in 2011 – meaning
tax hikes and spending restraint – “could take a huge slice off next
year’s growth rate. If so, overnight rates might have to remain
stimulative, as rates at 2.5 per cent or less would be,” says Mr.
Shenfeld.

-   Austere foreign budgets will likely impede global growth. “If the
U.S., the U.K., and Japan all move from huge stimulus to even modest
restraint, Canada will feel it in our export prospects come 2011.”

-   Banking reforms in G-20 countries require added capital and reduced
leverage that will cut into global bank lending capacity, notes Mr.
Shenfeld. “The more credit tightens due to regulatory actions, the
less need for central banks to do it through the overnight rate.”

The complete CIBC World Markets report is available at:

http://research.cibcwm.com/economic_public/download/gps_apr10.pdf

    -   The long path to sustained growth south of the border means an
        interest rate hike there is likely several quarters away. "Why should
        Governor Carney care about getting too far ahead of the U.S. Federal
        Reserve (in raising interest rates)? Because when the Fed is still on
        hold, it reflects Washington's judgement that a self-sustaining
        rebound isn't yet assured," says Mr. Shenfeld.

    -   Unmatched rate increases in the U.S. could also "send the Canadian
        dollar into record territory," he adds. "While factories are
        recovering in Canada alongside a global industrial revival, output
        remains nearly 20% below the pre-recession peak, and wages are now
        substantially above those stateside without the productivity gains to
        match. There's only so much of a competitive challenge that non-
        resource exporters can take in short order."

    -   The recent uptick in inflation is not expected to continue as
        Canadian production is below its potential. This "output gap" serves
        to restrain wages and other costs, ultimately reducing the need to
        hike rates to curb inflation.

    -   Federal and provincial belt tightening beginning in 2011 - meaning
        tax hikes and spending restraint - "could take a huge slice off next
        year's growth rate. If so, overnight rates might have to remain
        stimulative, as rates at 2.5 per cent or less would be," says Mr.
        Shenfeld.

    -   Austere foreign budgets will likely impede global growth. "If the
        U.S., the U.K., and Japan all move from huge stimulus to even modest
        restraint, Canada will feel it in our export prospects come 2011."

    -   Banking reforms in G-20 countries require added capital and reduced
        leverage that will cut into global bank lending capacity, notes Mr.
        Shenfeld. "The more credit tightens due to regulatory actions, the
        less need for central banks to do it through the overnight rate."

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