Inflation pressures Canada to raise rates

The percentage of Canadian executives predicting faster inflation is at a four-year high relative to the central bank target rate, adding to pressure on the bank to raise borrowing costs. Eighty per cent of company executives expect the inflation rate to be above two per cent over the next two years, according a quarterly Bank of Canada survey released last week. The central bank's policy rate stands at one per cent, making the gap between the two measures the widest since the second quarter of 2007, according to RBC Capital Markets and data compiled by Bloomberg. Indicators signalling higher inflation and reduced slack in the Canadian economy are increasing the pressure on Bank of Canada Governor Mark Carney to raise borrowing costs. Though the bank is forecast to maintain the one per cent rate at its meeting today amid financial turmoil in Europe and the US, policymakers may raise rates as early as September, according to RBC Capital Markets. "Under normal conditions, these developments would have proved fertile ground for a rate hike," RBC's Mark Chandler said in a July 14 research report. "However, recent financial market volatility has been anything but normal." Interest-rate futures show traders expect Carney will stand pat until 2012 as the European debt crisis and risks the US might lose its top credit rating offset concerns about rising consumer prices in Canada. "If the world was a more favourable place, Carney would have been nudging towards a rate increase," Chandler, head of Canadian currency and rates strategy, said. "The notion of excess slack being taken up, which is why he suggested rates would have to rise at some point, that is definitely still in place." Canada's consumer price index probably rose at a 3.6 per cent annualised pace in June, according to the median of 13 forecasts compiled by Bloomberg. The index rose 3.7 per cent in May, the fastest since 2003 and exceeding the highest of economists' projections. Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government widened 1 basis point last week to 1.33 percentage points, from 1.32 the week before, according to a Bank of America Merrill Lynch index. Yields fell to 3.59 per cent, from 3.66 per cent. Canadian corporate bonds have returned 1.5 per cent in July, compared with a gain of 1.4 per cent for Canadian government bonds, Bank of America Merrill Lynch indexes showed. US corporate bonds made 1.2 per cent through July 14. Provincial bond's relative yields widened 2 basis points last week to 0.56 percentage point, from 0.54 percentage point on July 8. Yields fell to 3.05 per cent from 3.12 a week earlier. The securities are up 1.7 per cent in July. Yields on five-year Government of Canada bonds fell 11 basis points last week to 2.13 per cent. The securities yielded 70 basis points more than equivalent Treasuries, out from 67 on July 8. Wagers that the Bank of Canada will raise interest rates this year have dropped to 32 per cent, from 92 per cent at the end of April, according to Bloomberg data based on overnight index swaps. The central bank has three rates meetings this year after today's. "With just one policy instrument to manage a plethora of influences, the Bank of Canada does not have an easy job even in the best of times," David Tulk, chief Canada macro strategist at Toronto-Dominion Bank's TD Securities unit, wrote in a note to clients. "The challenge is especially acute in the current environment, as the gulf between domestic and international trends that the bank is trying to straddle continues to widen." Eight banks failed Eur-opean Union stress tests last week and Ireland was downgraded by Moody's Investors Service. The US administration has warned that it will be unable to pay all its bills and that the nation's credit rating will be downgraded if the $14.3 trillion US debt ceiling isn't raised by the August 2 deadline. US House Republicans plan a vote this week on a measure to cut spending, cap expenditures and condition a $2.4 trillion increase in the debt ceiling on passage of a constitutional amendment to balance the budget. From / Gulf News