Rate hikes in Canada, N.Z. won't lead to global tightening

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By Palash R. Ghosh | June 11, 2010 10:40 AM EST

The central banks of two Western industrialized nations, Canada and New Zealand, have just hiked their benchmark interest rates, in stark contrast to the vast majority of their peers who remain committed – seemingly for the long-term – to an easy monetary policy.

Might Canada and New Zealand lead a new wave of higher interest rates around the developed world?

Not likely, as these two nations (along with Australia) have very different economies from the Europeans and Americans.

Indeed, both the Bank of England and European Central Bank kept their overnight rates at emergency-low levels today, with little hope of tightening in the near future.

“Canada really wasn't affected by the global banking crisis because their well-regulated banking industry did not participate in mortgage-backed securities,” said James A Cox, Managing Partner of Harris Financial Group.
“So their financial institutions didn't become burdened with over-leveraged debt as banks in the US and Western Europe did. The Canadian system, more or less, is running normally.”

The Bank of Canada (BoC) – which last week boosted its overnight rate by 0.25% to 0.50% -- was the first central bank from the Group of Seven nations to raise rates since 2008.

Cox notes that the Canadian economy, a resource-rich, export-driven machine, is fairly solid, with strong GDP and jobs growth. “An over-accomodative monetary policy was no longer necessary,” he added. “I expect the Bank of Canada to incrementally raise rates over the next year or so. They have a self-sustaining economy.”

However, it should be noted that after raising rates last week, the BoC struck a somewhat cautionary tone, and expressed concern about the potential impact of the European debt malaise on Canada – suggesting future rate hikes were not a certainty.

“Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments,” the BoC wrote.

Meanwhile, in New Zealand -- also a resource-heavy, exporting nation –
the The Reserve Bank of New Zealand (RBNZ) pushed up its official cash rate to 2.75% from an all-time low of 2.5%. Here, raising rates was largely an inflation story.

“New Zealand faces some genuine inflationary pressures,” Cox said. “Raising rates is necessary to tamp down undue price rises. The central banks down under are managing their economies very well.”

The RBNZ expects inflation to climb to 5.3% next year largely due to a planned increase in the nation's sales tax rate. (The Bank is mandated to keep inflation between 1% and 3%.)

Accompanying the rate hike – its first in three years – RBNZ suggested it was not concerned about the EuroZone debt crisis impacting its economy, paving the way for further rate hikes over the next year, amidst a strengthening economy.

Naturally, higher interest rates will also pump up demand for the New Zealand dollar through increased use of carry trades – where investors investors borrow low-yielding currencies to invest in higher-yielding currencies (like the NZ dollar). Nevertheless, the RBNZ's primary focus seems to be on containing inflation.

Thus, while Canada and New Zealand now have the “luxury” of dealing with inflation, most of the remaining Western industrialized nations are worried about deflation – hence, the dichotomy of monetary policies across the developed world.

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