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Canada Becomes First G7 Nation to Raise Overnight Rates

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Canada became the first member of the Group of Seven (G7) to raise its target for the overnight rate, but as uncertainty looms in the global markets, economists say it is unlikely other G7 countries will soon follow suit. On Tuesday, the Bank of Canada announced its decision to raise its target for the overnight rate — the rate banks lend to each other — to 0.5%, an increase of 0.25%. As a result, the bank rate — the minimum rate the Bank of Canada loans short-term advances to banks — increased to 0.75%, while the deposit rate remained at 0.25%. The move re-establishes the normal operating band of 50 basis points (bps) for the overnight rate, the Bank of Canada said. "The global economic recovery is proceeding but is increasingly uneven across countries, with strong momentum in emerging market economies, some consolidation of the recovery in the United States, Japan and other industrialized economies, and the possibility of renewed weakness in Europe," Canada's central bank said in a statement, adding "The required rebalancing of global growth has not yet materialized." Canada's economy, while not immune to the global economic downturn, is faring better than its neighbor to the south. According to the Bank of Canada, the country's economy grew by 6.1% in Q110, led by increases in the housing and consumer spending sectors. In addition, employment is also expanding. However, going forward, the bank expects household spending to decelerate to a pace "more consistent with income growth." The Bank of Canada noted its decision comes in light of recovery in other countries, which remains heavily dependent on monetary and fiscal stimulus. The broad forces of household, bank, and sovereign deleveraging will add to the variability, and temper the pace, of global growth, the bank added. Paul Ashworth, a senior economist at the Toronto-based Capital Economics wrote in commentary that the tone of the Bank of Canada's statement suggests the interest rate increase is not necessarily the first step on a long march towards a normalization of interest rates, nor are other members of the G7 — France, Germany, Italy, Japan, the United Kingdom and the US — likely to follow anytime soon, as the economic fundamentals in Canada are very different from other member countries, especially in the US. Compare Canada's 3% growth in gross domestic product (GDP) to conditions in the US, where the unemployment rate of 9.9% is still close to its peak and well above the long-term average of 5%, Ashworth said. In addition, core inflation in the US is at a 44-year low of only 0.9%, and money and credit aggregates are shrinking and house prices are starting to fall again. "Under the circumstances, what the Bank of Canada has done is probably prudent and we expect it to hike rates to about 1.25% by year-end," he said. "In contrast, we still expect it will be 2012 before the US Fed starts to tighten policy." Meetings of the G7 countries are conducted several times a year and are attended by the finance ministers of the respective countries. The heads of government in the  Group of Eight, which is comprised of the G7 countries and Russia, meets annually. Write to Austin Kilgore.

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