Rates hold the key

This will be the year when everything changes. Already a few countries, led by Australia, have started the process of moving rates higher. China has sent tremors through financial markets by tightening lending regulations to cool that country's overheating economy.

Make no mistake: there is more news of this type coming. As the global economy recovers, central banks are going to begin to move away from the current low rate environment. That will have an effect on bond prices, the stock market, consumer credit, house sales, corporate financing, and just about anything else you can think of that is associated with money.

The magnitude of the impact will depend in large part on the pace at which the central banks move. Bank of Canada Governor Mark Carney is on record as saying that the target overnight rate will remain at 0.25 per cent until the end of the second quarter barring a dramatic shift in the economic climate. After that, nothing is certain.

The first rate-setting after June 30 will take place on July 20 with the next one due on September 8. In an interest rate forecast released earlier this month, RBC Capital Markets predicted we will see the overnight rate at 0.75 per cent by the end of September, an increase of 50 basis points (bp). Unless inflation emerges as a serious concern in the interim the Bank will probably choose to implement two quarter-point hikes to ease the shock to the financial system -- assuming the RBC forecast is on target.

By the end of 2010, RBC predicts the target overnight rate will be at 1.25 per cent, which implies another 50 bp increase in the fourth quarter. Of course, that would mean that interest rates across the board would rise on everything from Treasury bill yields to mortgage rates.