As widely anticipated by economists, the Bank of Canada (BoC) raised its trendsetting policy rate to 1.5 per cent, up from 1.25 per cent on Wednesday. It was the fourth rate increase in the last 12 months.
The central bank said it expects the Canadian economy to expand by 2 per cent per year on average between 2018 and 2020, noting that recently implemented tariffs on steel and aluminium will likely have only “modest” effects on growth and inflation.
Consumer price inflation is expected to edge up to 2.5 per cent before returning to around 2 per cent by the second half of 2019.
WATCH: Bank of Canada raises benchmark interest rate to 1.5%
The bank predicted the impact of U.S. duties on Canada and Ottawa’s retaliatory measures will shave nearly 0.7 per cent from Canada’s economic growth by the end of 2020. However, that negative blow should be largely offset by the positives for Canada from higher oil prices and the stronger U.S. economy, the central bank said.
The BoC also warned that U.S. tariffs on the auto sector’s integrated cross-border supply chains would have “large impacts on investment and employment.” But the bank did not quantify the possible effects of auto tariffs on Wednesday.
U.S. President Donald Trump has proposed duties of 25 per cent on all auto imports, including those coming from Canada. The U.S. Department of Commerce started investigating the option of imposing the tariffs in May.
WATCH: What the Bank of Canada’s rising interest rate means for you
Canadian businesses must also contend with the uncertainty surrounding the difficult renegotiation of NAFTA, for which talks have stalled.
Speaking in the wake of reports that the U.S. is readying another round of tariffs on $200 billion worth of Chinese imports, the BoC also has its eye on how widening global trade disputes will affect the world’s economy.
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It warned that “escalating trade tensions pose considerable risks to the outlook” at the global level.
Still, BoC governor Stephen Poloz previously signalled that the bank would be guided by actual data rather than trade rhetoric in its assessment of where interest rates should go.
Looking ahead, the bank predicts Canadian growth will continue to see bigger contributions from exports and business investment, which were both stronger than expected in the first three months of the year.
At the same time, household spending will represent a smaller and smaller share of overall growth due to the dampening effects of higher interest rates and stricter mortgage rules, it said.
A diminished reliance on the housing sector and consumption as engines of growth is “something the BoC has been waiting for years to see,” BMO economist Benjamin Reitzes said in a note to clients shortly after the rate announcement.
However, “while the wait appears to be over, protectionism is a risk to that process,” he added.
Moving forward, the bank said it expects higher interest rates will be necessary over time to keep inflation near its target, however, it intends to continue along a gradual, data-dependent approach.
– With files from Andy Blatchford at the Canadian Press