BOC should be on guard with Fed to raise interest rates

Bloomberg

The USA Federal Reserve will raise interest rates as many as six times over the next 18 months and the Bank of Canada should be getting ready with increases of its own, Bank of Nova Scotia Chief Economist Jean-Francois Perrault said.
While both central banks will be cautious about snuffing out recoveries, the USA job market will have bounced back by September and the Bank of Canada has forecast inflation will be sustained at 2 percent in the second half of 2017, with the economy operating close to capacity, Perrault said. He sees Fed Chair Janet Yellen tightening twice this year and three or four times next year, while Bank of Canada Governor Stephen Poloz begins to increase around the middle of next year.
“They should in principle be relatively neutral at this point in time or start thinking about raising interest rates,” Perrault said Tuesday in an interview at Bloomberg’s Toronto newsroom, as monetary policy works with a 12 to 18 month lag. “It does suggest to us that were things to materialise as the bank thinks, that even if they start raising interest rates mid-next year, they are to some extent going to be behind the curve.”

Make Sure
Perrault’s forecast is a little ahead of other analysts. The median estimate of economists surveyed for the Bank of Canada to keep its overnight rate unchanged at 0.5 percent until the fourth quarter of next year.
Having been scarred by its December experience, in which it raised the upper band of the target for its federal funds rate to 0.5 percent from 0.25 percent only to see the USA recovery wane, the Fed will make sure the economy is strong enough to withstand a series of hikes, this time, Perrault said.
“They are going to make extra damn sure that they have got the diagnosis right and this is in fact the launch of a tightening cycle,” he said.
The U.S. presidential election in November is unlikely to deter the central bank, said Perrault, who predicted increases in September and maybe December.
Governor Poloz has expressed caution about moving too quickly with rate increases as well, saying in a speech last week the recovery requires patience and will be underpinned by a rotation toward service companies and other exporters, away from depressed oil investment.

Weaker Dollar
If the Fed does move as Perrault expects, Canada’s policy interest rate would fall below the Fed’s for the first time since 2007.
That would weaken the Canadian dollar, boosting exporters, Perrault said. He predicts the currency will drop to C$1.30 per U.S. dollar by the end of the year or about 77 U.S. cents. The currency traded 77.9 U.S. cents at 4:12 p.m. in Toronto on Wednesday, or C$1.2836.
Low interest rates have spurred housing booms in Toronto and Vancouver, fanned by foreign buyers. The federal government could impose tougher down payments but city or provincial governments might be better placed to act, Perrault said. Setting higher taxes on land transfers for houses owned for less than 18 months could do the trick, he said.
Housing Boom
“The most efficient ways are probably dealing directly with the land-transfer tax system at the municipal or the provincial level,” he said.
Even so, the rise of the million-dollar home in Vancouver doesn’t mean a crash is coming, especially in a world where prices have moved even higher in cities like London and Paris, Perrault said.
“Housing booms need a trigger to start to unwind,” he said. “Basically since I’ve been an adult, people have thought of Vancouver prices as being ridiculously high, and they keep getting more and more expensive. People adjust and adapt.”