By Greg Quinn and Chris Fournier – May 21, 2010 Email Share Print
Traders are reducing bets that the Bank of Canada will raise interest rates in June amid a European sovereign-debt crisis, even as inflation quickens toward the bank’s 2 percent target.

Canada’s nine-month overnight index swap rate, which marks what traders expect the central bank’s policy rate will average over that period, closed yesterday at 0.8150 percent, from 1.0050 percent on April 21. That shows traders are “significantly trimming bets” on rate increases in both June and July, according to Blake Jespersen, director of foreign exchange in Toronto at Bank of Montreal.

“This has come off dramatically, from a hike fully priced at every meeting,” Jespersen said. “We don’t think they’re going to hike in June if things in Europe continue to unfold this way.”

Economists in a Bloomberg survey predict higher interest rates in June, with 11 of the 12 respondents forecasting the central bank will raise borrowing costs by a quarter-percentage point to 0.5 percent.

In an unprecedented move, the European Central Bank started buying bonds last week to reduce yields in countries such as Greece and Portugal after investors questioned those countries’ ability to reduce budget deficits. The euro traded yesterday near a four-year low against the greenback.

Consumer Price Data

Bank of Canada Governor Mark Carney’s decision on how fast to raise rates may be influenced by today’s consumer price report. The year-over-year inflation rate accelerated to 1.8 percent in April from 1.4 percent in the previous month, Statistics Canada said. That’s faster than the 1.7 percent median forecast of 21 economists surveyed by Bloomberg News.

“We do not expect an outcome that will cement either a pause or a rate hike,” Eric Lascelles, chief economics and rates strategist at Toronto Dominion Bank in Toronto, wrote in a note to clients yesterday. “Instead, the European fiscal crisis will provide the main input into the decision.”

Elsewhere in credit markets, the extra yield investors demanded to own Canadian corporate rather than federal government debt ended yesterday at 144 basis points, compared with 145 basis points the day before, according to a Bank of America Merrill Lynch Index. It was as tight this year as 114 basis points on March 19.

Yield Tumbles

The yield on the Canadian government two-year bond plunged yesterday to its lowest close since March 18 as investors speculated Europe may not be able to contain its sovereign-debt crisis and the global economy may suffer.

Export Development Canada plans to sell $1 billion of five- year notes in U.S. dollars, according to a person familiar with the offering. The debt may yield 3 to 5 basis points more than the benchmark mid-swap rate, said the person, who declined to be identified because terms aren’t set. A basis point is 0.01 percentage point.

EDC hired Bank of America Corp., Citigroup Inc., Deutsche Bank AG and Toronto Dominion to manage the sale, according to a statement from Bank of America.

Canada will auction C$700 million ($654 million) of 30-year inflation-linked bonds on May 26, according to a statement on the Bank of Canada’s website. The 1.5 percent securities mature in December 2044.

Traders increased bets on a Bank of Canada rate increase on June 1 after policy makers’ April 20 statement dropped a pledge to keep the key interest rate at 0.25 percent until July. Carney said the timing of further action would depend on economic growth and inflation. The yield on the nine-month overnight index swap rose from 0.785 percent two days before the last rate announcement to more than 1 percent the day after.

The central bank predicted in a report on April 22 that inflation will be “slightly higher” than its 2 percent target over the next year. Carney said in testimony to Parliament the following week that future rate moves aren’t “pre-ordained” and depend on the pace of inflation and a rebound from last year’s recession.

To contact the reporters on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net; Chris Fournier in Montreal at cfournier3@bloomberg.net

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