In a widely anticipated move, the Bank of Canada (BoC) raised its trend-setting interest rate by a quarter of a percentage point to 1.75 per cent on Wednesday. It was the fifth time that BoC governor Stephen Poloz lifted rates since mid-2017.
Ever since the previous rate increase in July, many economists had been predicting one more hike this year, likely to come in October. And the move appeared all but sealed after the signing of the new United States Mexico-Canada Agreement (USMCA), which removed considerable uncertainty that analysts worried had been weighing on Canada’s growth.
Central banks generally raise interest rates to keep the economy from overheating and generating excessive inflation. That’s because higher borrowing costs tend to moderate economic activity.
Canada’s central bank has been slowly raising rates from historic lows after the end of the 2014-2016 recession in Alberta and today said interest rates have further up to go. But in a departure from previous statements, the bank dropped the word “gradual” when describing the pace of future hikes.
WATCH: How rising interest rates affect borrowers and savers
Financial markets will interpret the omission as a signal that the BoC is leaving the door open for consecutive rate increases, with one possibly happening as early as December, Avery Shenfeld, chief economist at CIBC Capital Markets said in a note to clients shortly after the announcements.
The BoC also said its key interest rate “will need to rise to a neutral stance” to keep inflation close to target. The central bank has estimated the neutral rate as near three per cent, Shenfeld noted.
“That’s more hawkish than we see as the likely outcome, as we’re not as optimistic on the economy’s ability to weather that dose of tightening,” he added.
The BoC said Canadians have been making spending adjustments in response to earlier rate hikes and stricter mortgage policies — and credit growth continues to moderate.
“As a result, household vulnerabilities are edging lower in a number of respects, although they remain elevated,” the statement said.
WATCH: ‘We’re in good shape’ Poloz on how interest rate hike will affect housing markets
The bank still expects consumer spending to continue expanding at a “healthy pace,” thanks in large part to the steady rise of incomes and high consumer confidence.
Until the hike Wednesday, the interest rate hadn’t been above 1.5 per cent since December 2008. At that time, during the financial crisis, the bank made a three-quarter-point cut to the benchmark, bringing it to 1.5 per cent from 2.25 per cent. The bank left the rate unchanged in September and senior deputy governor Carolyn Wilkins later said the unknown consequences of the North American trade talks — as well as the tit-for-tat tariff dispute — were front and centre in the decision.
Following the USMCA agreement, the bank now expects lingering trade tensions — such as U.S. metals tariffs and Canada’s countermeasures — to lower business investment by just 0.7 per cent by the end of 2020, compared with the 1.4 per cent reduction it had predicted in July.
Exports are now expected to take a negative hit of just 0.3 per cent compared to the previous prediction of a 0.7 per cent reduction. The bank pointed to data that indicates the tariff quarrel has led to reductions in steel exports and imports, but have yet to show a notable impact on aluminum shipments. The projections were laid out in the latest edition of bank’s quarterly monetary policy report, which was also released Wednesday.
WATCH: Wilkins on dropping word ‘gradual’ when describing pace of rate hikes
The report predicted business investment — outside the oil and gas sector — will expand due to solid domestic and foreign demand. It noted, however, Canada is still grappling with competitiveness challenges linked to major U.S. tax and regulatory changes as well as ongoing uncertainties around pipeline approval. The bank anticipates these factors will encourage some exporters to delay their investments or to make them outside Canada.
Exports are expected to continue growing at a moderate clip, the bank said, but they will face limitations from several factors — including transportation capacity constraints, global trade uncertainty and stiff competition, particularly from the U.S.
In a batch of updated economic forecasts, the bank predicted Canada’s real gross domestic product to expand 2.1 per cent in 2019, down from its July call of 2.2 per cent, and by 1.9 per cent in 2020. Its growth projection for this year has been increased slightly to 2.1 per cent, up from its previous prediction of two per cent.
Inflation, which reached 2.7 per cent in the third quarter of 2018, is expected to slide back close to two per cent by next spring as temporary effects from higher air fares, pricier gasoline and minimum wage hikes in some provinces fade away. The bank noted that core inflation readings, which omit more volatile items like pump prices, have stayed close to two per cent.
The report also noted that the economic activity generated by the recent legalization of recreational cannabis will likely have just a small impact on monetary policy decisions.
— with files from the Canadian Press
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