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Economic risks, well-anchored inflation expectations and a strong Canadian dollar have prompted TD Economics to push back its interest rate hike forecast.

 

Rather than an increase from the Bank of Canada in 2011, TD now believes the tightening of monetary policy will arrive early in 2012, with the overnight rate climbing to just 2.00% by the middle of the year.

 

“With the U.S. Federal Reserve on hold, the Bank of Canada is also constrained in raising interest rates, as widening interest rate spreads would boost the Canadian dollar that is already above parity,” said Craig Alexander, TD’s chief economist.

 

He also said the traditional framework for thinking about monetary policy fails to account for the atypical economic and financial environment that currently exists.

 

“At the most basic level, the world economy has not made as much progress as we had hoped in dealing with the legacies of the financial crisis and recession,” Mr. Alexander said in a report. “This will have an impact on the future conduct of Canadian monetary policy.”

 

He thinks Canada’s central bank could raise rates from 1.00% to 2.00%, then stop to assess how the economy responds and how international events are playing out. The economist said such a pause would last several months.

 

If this more accomodative policy stance leads to stronger domestic demand, this would induce the need for higher rates, Mr. Alexander said. The other factor that could change his outlook is inflation.

 

“If solid economic data leads markets to fret about the Bank falling behind the inflation curve, then all bets are off and the central bank will start hiking,” he said. “The credibility of an inflation fighter is too valuable to lose.”

 

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