Canada, Raising Rates, May Have Foggy Crystal Ball Mon Jul 29,12:00 PM ET
By Amran Abocar
TORONTO (Reuters) - Crystals balls are essential gadgets for any self-respecting central banker, but analysts are beginning to wonder if the Canadian model is fogged, giving the Bank of Canada a distorted picture of economic trends.
In steep contrast to a cautious U.S. Federal Reserve ( news - web sites), Canada is forecasting strong growth and surprising observers with its steely determination to tighten monetary policy.
Canada's central bank has raised interest rates three times since April, rolling rolls back some of the stimulus that took rates to 40-year lows, and Bank of Canada Governor David Dodge says more rate hikes are on the way.
"I think they just maybe have their blinders on," said Aron Gampel, senior economist at Scotia Capital Markets. "And the blinders are more focused on the domestic economy which for the most part is still recording impressive gains."
South of the border, Alan Greenspan ( news - web sites) is peering into a ball that shows a much murkier economic future, and the veteran guardian of U.S. economic prosperity has made clear that interest rates are going to stay at today's low levels.
In Canada, economists are listening to those conflicting views with unease and ratcheting down their expectations.
"Both Mr. Greenspan and Mr. Dodge have released monetary policy reports in the last two weeks and the market is saying we don't believe that, just like we don't believe any of the auditors' statements." said John Johnston, chief economist for the Americas at RBC Capital Markets.
"In many ways, they're almost treating the two central bank heads as CEOs and discounting what they have to say. There's a belief that they have no option but to talk up the economy and fudge their forecasts as a result."
The Bank of Canada was long content to take its cues on rates from the Fed until it went on a tear this year, becoming the first central bank in the Group of Seven rich nations to start raising rates. Economists say they will give the Canadians benefit of the doubt for now.
They point to differences in the two economies -- a booming labor and housing market and shallower downturn in Canada than in the United States -- which suggest a made-in-Canada policy is just the ticket for an economy that jumped 6 percent in the first quarter and probably grew 4.5 percent in the second.
DIFFERENT HORSES FOR DIFFERENT COURSES
"It's not that David Dodge is looking through rose-colored glasses and Alan Greenspan is looking through very dark sunglasses," Tim O'Neill, chief economist at Bank of Montreal said. "It's that the evidence they are working with is different and therefore their policies reflect that."
But memory of Dodge's optimism about the economy last year, even as it ground to a halt, is still fresh in many minds.
Analysts, who largely applaud the central bank for its deft guidance of the economy, question whether it is being cautious enough in light of the troubles facing the United States, Canada's biggest trading partner, turmoil in financial markets and signs the domestic economy is coming off its red-hot pace.
"I think they're a bit too optimistic. Central banks all over the world have revised their outlooks," said Sherry Cooper, chief economist at BMO Nesbitt Burns.
Dodge swatted aside such worries last week as he offered his second upbeat forecast in less than two weeks.
"We in Canada will set monetary policy according to conditions here, the Federal Reserve will set policy according to conditions in the United States," he said.
In a monetary policy update, the bank struck a defiantly bullish tone on growth prospects and said it will keep lifting rates to keep the economy from overheating, although it also mentioned risks from turbulent stock markets.
Canada's overnight rate stands at 2.75 percent while the corresponding U.S. federal funds rate is at 1.75 percent.
Greenspan wants to keep the U.S. system flush with cash amid accounting scandals that have wiped billions off stock markets, casting new doubts on an already weak recovery. Most dealers expect the Fed to hold rates steady till next year.
Yet, despite the Bank of Canada's hawkish view, most Canadian primary dealers do not believe interest rates will go up again in September, according to a Reuters poll last week.
The poll also found that five of 13 primary dealers, those who work directly with the central bank in the market, expect the bank will not hike rates again this year at all.
"There is some skepticism and definitely the market is testing the bank's wherewithal to follow through on further rate increases," said Derek Burleton, senior economist at Toronto-Dominion Bank.