March 24, 2010

Bank of Canada Governor Mark Carney may use a speech and press conference today to prepare investors for interest-rate increases in coming months, saying an economic rebound has generated faster-than-expected inflation and given exporters some cushion against a rising currency.

Carney has pledged to keep his benchmark interest rate at a record low 0.25% through the end of June unless the inflation outlook changes. He has also said the economy will operate with slack through the middle of next year, in part because a strong Canadian dollar is a drag on growth.

The outlook for prices may have changed after last week's report showing the bank's preferred inflation gauge was half a percentage point higher than policy makers forecast. The economy has also shown signs of rebounding more quickly from last year's recession, with the fastest growth since 2000 last quarter and recent data showing gains in manufacturing and retail sales.

"He will probably prepare the public that we are moving into a period for rising rates in Canada, the speed determined by whether this pressure on inflation is transitory or not," said Paul Ferley, assistant chief economist at Royal Bank of Canada in Toronto.

Carney "will continue to remind people they haven't lost sight of the Canadian dollar," Ferley said. "At the moment the economy seems to be able to handle where it's at."

The speech, "The Virtue of Productivity in a Wicked World," is scheduled to be published at 12:50 p.m., with a press conference slated for 2:10 p.m.

The core inflation rate, which excludes eight volatile items, was 2.1 percent in February, Statistics Canada said March 19. The bank predicted in January that core inflation would average 1.6 percent in the first quarter, and not reach 2 percent until the third quarter of next year.

The faster-than-expected figure increased overnight index swap rates as investors bet on earlier interest-rate increases. The 6-month overnight index swap rate was 0.395 percent yesterday, up from 0.335 percent a week ago and the highest in almost a year.

Carney has a "difficult" task because part of the core rate's rise was linked to a temporary rise in accommodation costs during the Vancouver Winter Olympics, said Craig Alexander, deputy chief economist at Toronto-Dominion Bank.

"If the Bank of Canada wanted to send out a signal on how the economy is doing relative to their last projection, they would have to acknowledge core inflation has been stickier and growth has been better than they anticipated," Alexander said.

Manufacturers were among the hardest-hit companies during Canada's recession last year and Carney has said the currency and a low volume of U.S. orders will be a drag on growth.

This year, the country's industrial stocks have gained 3.3 percent on the Standard & Poor's/TSX Composite Index, compared with a 2.5 percent rise for the whole index.

Finance Minister Jim Flaherty, Industry Minister Tony Clement and former Bank of Canada Governor David Dodge said last week that companies are in a better position to deal with a stronger currency than the last time it reached parity with the U.S. dollar in 2007.

The currency traded for C$1.0159 and has gained 3.7 percent against the U.S. dollar this year.

The currency's rise may now be helping slow inflation more than derailing an economic recovery, Alexander said.

"The Canadian dollar is pushing the economy back towards the Bank of Canada's forecast," he said. "It's possible that the bank won't be significantly concerned about the appreciation because it brings the economy back to a slower rate of growth."

Carney could also save any major economic update for next month's interest-rate decision and revised quarterly economic forecast, said Michael Gregory, senior economist at BMO Capital Markets in Toronto. He predicts a July rate increase.

"They have admitted themselves that core inflation has been sticky," Gregory said. "It takes more than one month to make a trend."