Interest Rate Outlook

As expected, the Bank of Canada held its overnight rate at 1 per cent at its March 1st meeting. In the absence of nascent geo-political risk and the soaring loonie, the stronger than expected pace of economic growth may have alone been enough to push the Bank to raise rates at its next meeting in April. However, the risk posed to the global economy by a still evolving situation in the MENA region along with the anti-inflationary (and potentially growth-subduing) impact of the loonie’s rise will likely see the Bank erring on the side of caution and therefore holding rates steady until the summer. Once the Bank resumes rate increases, we expect the overnight rate to rise from one per cent to between 1.75 and 2 per cent by end of 2011.

A much improved economic outlook has prompted a steepening of both the Canadian and US yield curves, with large movements occurring in the 5-10 year maturities. However, some of the increase has been offset by growing risk aversion as investors flee back into safe assets to wait out events in the MENA region. The unpredictability (in both the severity and duration) of this still developing situation should translate to volatility in bond yields going forward, but we maintain that Canadian interest rates will ultimately end the year higher.