Bank of Canada could lag Fed in ‘unprecedented’ rate rise timing

A rise in interest rates in the United States is unlikely to be copied right away by the Bank of Canada, which may be good news for borrowers but also signals more challenges ahead for our economy.

A pair of Scotiabank economists is warning of the “serious risk of an unprecedented lag,” in rate rises between Canada and the U.S.

“We think the Bank of Canada will lag the Federal Reserve in starting to raise rates and will also lag behind in terms of the cumulative pace of hikes over the cycle ahead,” says the report from economists Derek Holt and Dov Zigler.

The U.S. is now expected to raise rates in the first half of 2015, earlier than some economists had expected. Canada won’t following suit, at least not right away, according to Holt and Zigler.

In an interview, Holt says the economies are growing at different speeds, with Canada lagging.

“I think things will be okay in Canada, but we had our biggest party in the past decade and sailed relatively unscathed through the crisis,” says Holt.

“That was wonderful then, but as a consequence we didn’t go through as much as a soft patch as the U.S. and therefore didn’t build up as much pent up demand for homes and cars and all the goodies that go into homes.”

It’s that pent up demand that he says will see growth in the U.S. outpace Canada’s.

Here at home, inflation is hovering around 1 per cent and the Bank of Canada recently forecast its 2-per-cent target won’t be reached for another couple of years, citing “significant” slack in the economy.

Holt says there’s a lot of uncertainty around the future direction of interest rates in Canada.

“It’s not a forgone conclusion the next move on interest rates is up, as opposed to down,” he says.

How the economy performs in the coming months should add more clarity.

“Households have to be cautious with respect to how they manage their exposure to [interest rate] risk,” Holt says.

The Bank of Canada has kept its key overnight rate unchanged at 1 per cent since September 2010. Last year, it dropped its warning about rising interest rates and instead adopted a neutral stance in its outlook.

“A weak global economy and elevated levels of uncertainty continued to dampen activity in Canada in 2013,” the Bank of Canada said in its 2013 Annual Report released late last week.

“Real economic activity in Canada in 2013 was disappointing, as the anticipated rebalancing of demand toward exports and investment spending failed to materialize.”

The good news for Canada’s fragile economy is that record household debt-to-income ratios among Canadians are “flatter.” The Bank of Canada is also calling for so-called “soft landing” in Canada’s housing market.

Many are closely watching the housing market’s performance this spring to get a sense of economic activity and consumer confidence.

Eyes will also be on moves by the big banks after Bank of Montreal announced last week that was dropping its five-year fixed-rate mortgage to 2.99 per cent, down from 3.49 per cent. It’s the same level that caused former finance minister Jim Flaherty to express concerns at this time last year about an overheated housing market.

His new replacement, Joe Oliver, has vowed to monitor the market closely, and pointed out the action taken by the government in recent years to tighten mortgage rules.

Still, Oliver called the Bank of Montreal’s mortgage move a “private” decision.