TORONTO, April 8 /CNW/ - Expectations that the Bank of Canada will begin raising interest rates this summer are on the mark but investors shouldn't be surprised if rates remain very low by historical standards right through 2011, according to a new report from CIBC World Markets Inc.

While markets may be aggressive in their expectations for rate hikes after the first increase expected in July, "a gradualist approach" is more likely and could see overnight rates at a still-low 2.5 per cent at the end of next year, says Avery Shenfeld, CIBC's chief economist, in the latest Global Positioning Strategy report.

Mr. Shenfeld lists several reasons for Bank of Canada Governor Mark Carney to "take it easy" on rate hikes after July, playing on the title of the classic Eagles song. The factors he sees supporting a more measured pace on rate hikes after the summer include the following:

-   The long path to sustained growth south of the border means an
        interest rate hike there is likely several quarters away. "Why should
        Governor Carney care about getting too far ahead of the U.S. Federal
        Reserve (in raising interest rates)? Because when the Fed is still on
        hold, it reflects Washington's judgement that a self-sustaining
        rebound isn't yet assured," says Mr. Shenfeld.

    -   Unmatched rate increases in the U.S. could also "send the Canadian
        dollar into record territory," he adds. "While factories are
        recovering in Canada alongside a global industrial revival, output
        remains nearly 20% below the pre-recession peak, and wages are now
        substantially above those stateside without the productivity gains to
        match. There's only so much of a competitive challenge that non-
        resource exporters can take in short order."

    -   The recent uptick in inflation is not expected to continue as
        Canadian production is below its potential. This "output gap" serves
        to restrain wages and other costs, ultimately reducing the need to
        hike rates to curb inflation.

    -   Federal and provincial belt tightening beginning in 2011 - meaning
        tax hikes and spending restraint - "could take a huge slice off next
        year's growth rate. If so, overnight rates might have to remain
        stimulative, as rates at 2.5 per cent or less would be," says Mr.
        Shenfeld.

    -   Austere foreign budgets will likely impede global growth. "If the
        U.S., the U.K., and Japan all move from huge stimulus to even modest
        restraint, Canada will feel it in our export prospects come 2011."

    -   Banking reforms in G-20 countries require added capital and reduced
        leverage that will cut into global bank lending capacity, notes Mr.
        Shenfeld. "The more credit tightens due to regulatory actions, the
        less need for central banks to do it through the overnight rate."

A gradual tightening of rates may indeed be good for Ottawa and provincial governments which, as noted elsewhere in the report, are expected to borrow money at elevated levels through 2011 via new bond issuance.

For commodities, higher interest rates are likely to slow rather than kill the current rally. Oil and Industrial metals may even continue to rise as the report notes in past cycles after monetary restraint.

The complete CIBC World Markets report is available at:

http://research.cibcwm.com/economic_public/download/gps_apr10.pdf

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