Close-up of Canada currency

The BoC cited a strong economy as it raised its target for the overnight rate to 1%. The bank rate is correspondingly 1.25%, and the deposit rate is 0.75%.

The move, likely a surprise for some, came less than a week after Statistics Canada numbers showed the economy expanded by an impressive 4.5% in Q2.

“Given the stronger-than-expected economic performance, Governing Council judges that today’s removal of some of the considerable monetary policy stimulus in place is warranted,” says the BoC in a release.

The central bank says economic data have been stronger than expected, supporting its view that growth is “becoming more broadly-based and self-sustaining.” For example, the bank cites robust consumer spending, “underpinned by continued solid employment and income growth,” as well as “more widespread strength” in business investment and exports.

Andrew Grantham, senior economist at CIBC, says in a note that the BoC’s reference to removing stimulus “suggests that, at these levels, the bank still views policy as very stimulative.” He notes that the bank says future hikes aren’t predetermined, which could be a reminder to markets it won’t be hiking a quarter point at every meeting.

“However, the statement didn’t go so far as to say the current level of stimulus is now appropriate, which has been a phrase used in the past,” says Grantham. “As such, markets may now start pricing in further moves, meaning today’s decision will be positive for the C$ and negative for fixed income.”

Growth outlook

The BoC notes that the housing sector is cooling in response to changes in tax and housing policies, and says it expects economic growth to moderate in the second half of 2017.

The bank also says global growth is becoming “synchronous,” as previously expected, based on strong economic indicators, including higher industrial commodity prices.

Read: Best Canadian commodity picks

“However, significant geopolitical risks and uncertainties around international trade and fiscal policies remain, leading to a weaker U.S. dollar against many major currencies,” says the bank, adding that the loonie has thereby appreciated on relative strength of Canada’s economy.

Read: Trade gap reveals potential for volatile loonie

Inflation remains below the 2% target, but the bank notes a slight increase in total CPI and core measures of inflation. That’s consistent with the dissipating impact of temporary price shocks and the absorption of economic slack, says the bank.

“Nonetheless, there remains some excess capacity in Canada’s labour market, and wage and price pressures are still more subdued than historical relationships would suggest, as observed in some other advanced economies,” the BoC says.

The central bank says it will monitor “elevated” household debt, adding that “close attention will be paid to the sensitivity of the economy” to higher rates.

Read: How growing household debt levels are putting Canada at risk

Further industry response

In a note, Desjardins senior economist Benoit P. Durocher says that, with strong GDP performance, expansionist monetary policy is no longer necessary. However, “the BoC appeared somewhat hasty to hike its key rate when it could have easily waited until October to do so,” he says. He expects a gradual approach to rate hikes as the BoC assesses the impact of rising interest rates on households.

Reduced excess capacity “sets the stage for another rate hike before year end,” says National Bank senior economist Krishen Rangasamy, in a note. “We are still calling for a rate hike in December, at which time more information will be available about the extent of fiscal stimulus both at the federal and provincial levels (e.g., pre-election spending in Ontario and Quebec).”

Also in a note, Derek Holt, vice-president and head of capital markets economics at Scotiabank, says, “A hike with a moderately hawkish bias met our expectations. One should not rule out another hike over the duration of 2017.” He notes that the loonie appreciated by about $0.02 versus the U.S. dollar post-statement, and the two-year bond yield increased by about 10 basis points.

The next scheduled date for announcing the benchmark interest rate is October 25, with the publication of the BoC’s monetary policy report.

Banks make their move

In response to the rate hike, RBC, TD, BMO, CIBC, Scotiabank and Desjardins today increased their prime lending rates by 25 basis points to 3.20% from 2.95%, effective Sept. 7, 2017.

Also read:

BoC issues 2018 rate decision calendar

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