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Canada Raises Rate Another 25 bps and Sees Further Hikes

Canada’s central bank raised its monetary policy rate by another 25 basis points to 1.50 percent and expects further rate hikes will be needed to keep inflation near its target though it will continue to be guided by the level of economic activity and inflation.

The Bank of Canada (BOC) has now raised its key rate, the target for the overnight rate, four times and by a total of 100 basis points in the last 12 months.

“Governing council expects that higher interest rates will be warranted to keep inflation near target and will continue to take a gradual approach, guided by incoming data,” the BOC said, confirming financial markets’ expectations that interest rates in Canada will continue to rise.

It is the BOC’s second rate hike this year and was expected by most economists following the central bank’s guidance in May in which it said economic data had reinforced the governing council’s view that “higher interest rates will be warranted to keep inflation near target.”

Today’s rate hike comes against a backdrop of growing volatility in global financial markets in response to concern over United States trade protectionism, including an increase in tariffs between Canada and the U.S., and negotiations over the North American Free Trade Agreement (NAFTA) that original went into effect in 1994.

In the July monetary policy report, the BOC estimated that uncertainty over future trading relationships and U.S. trade actions already implemented will subtract about 0.67 percent from Canada’s Gross Domestic Product by the end of 2020, an amount BOC described as “modest.”

U.S. tariffs on steel and aluminum imposed on June 1 is estimated to reduce Canadian exports by C$3.6 billion, or 0.6 percent, and mostly be felt in the second half of this year.

The impact of Canada’s countermeasures are expected to reduce imports by C$3.9 billion, or 0.6 percent, by raising the cost of users of steel, aluminum and iron, temporarily boosting inflation by about 0.1 percentage point until the third quarter of 2019.

Tensions and uncertainty over trade are taking place against still-solid global growth that has boosted oil prices and stronger-than-expected U.S. growth that has weakened the Canadian dollar while the economy is operating close to capacity.

The BOC raised its forecast for Canada’s economic growth in 2019 to 2.2 percent from April’s forecast of 2.1 percent and the 2020 forecast to 1.9 percent from 1.8 percent.

The forecast for growth this year was left at 2.0 percent, down from 3.0 percent in 2017, with the composition of growth shifting away from household spending towards business investment and exports as households adjust to higher interest rates and tighter mortgage regulations.

Inflation is seen remaining close to the bank’s target of 2.0 percent though it will accelerate to 2.5 percent in the third and fourth quarters of this year and average 2.4 percent for the year. It will then ease in 2019 but still average 2.2 percent and then 2.1 percent in 2020.

The Canadian dollar briefly rose on BOC’s rate hike but then eased to trade at 1.314 to the U.S. dollar, down 4.3 percent this year.

The Bank of Canada issued the following statement:

“The Bank of Canada today increased its target for the overnight rate to 1 ½ per cent. The Bank Rate is correspondingly 1 ¾ per cent and the deposit rate is 1 ¼ per cent.

The Bank expects the global economy to grow by about 3 ¾ per cent in 2018 and 3 ½ per cent in 2019, in line with the April Monetary Policy Report (MPR). The US economy is proving stronger than expected, reinforcing market expectations of higher policy rates and pushing up the US dollar. This is contributing to financial stresses in some emerging market economies. Meanwhile, oil prices have risen. Yet, the Canadian dollar is lower, reflecting broad-based US dollar strength and concerns about trade actions. The possibility of more trade protectionism is the most important threat to global prospects.

Canada’s economy continues to operate close to its capacity and the composition of growth is shifting. Temporary factors are causing volatility in quarterly growth rates: the Bank projects a pick-up to 2.8 per cent in the second quarter and a moderation to 1.5 per cent in the third. Household spending is being dampened by higher interest rates and tighter mortgage lending guidelines. Recent data suggest housing markets are beginning to stabilize following a weak start to 2018. Meanwhile, exports are being buoyed by strong global demand and higher commodity prices. Business investment is growing in response to solid demand growth and capacity pressures, although trade tensions are weighing on investment in some sectors. Overall, the Bank still expects average growth of close to 2 per cent over 2018-2020.

CPI and the Bank’s core measures of inflation remain near 2 per cent, consistent with an economy operating close to capacity. CPI inflation is expected to edge up further to about 2.5 per cent before settling back to 2 per cent by the second half of 2019. The Bank estimates that underlying wage growth is running at about 2.3 per cent, slower than would be expected in a labour market with no slack.

As in April, the projection incorporates an estimate of the impact of trade uncertainty on Canadian investment and exports. This effect is now judged to be larger, given mounting trade tensions.

The July projection also incorporates the estimated impact of tariffs on steel and aluminum recently imposed by the United States, as well as the countermeasures enacted by Canada. Although there will be difficult adjustments for some industries and their workers, the effect of these measures on Canadian growth and inflation is expected to be modest.

Governing Council expects that higher interest rates will be warranted to keep inflation near target and will continue to take a gradual approach, guided by incoming data. In particular, the Bank is monitoring the economy’s adjustment to higher interest rates and the evolution of capacity and wage pressures, as well as the response of companies and consumers to trade actions. ”

This article originally appeared on CentralBankNews.info and is reproduced here with permission from the author.

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