BoC raises key rate to 1.75%, citing strong economy

By Staff, with files from The Canadian Press | October 24, 2018 | Last updated on October 24, 2018
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The Bank of Canada raised its key rate Wednesday, citing “solid” economic growth in Canada and “healthy” growth globally.

The central bank raised its overnight target rate to 1.75%, up a quarter-point from 1.5%. It was the bank’s first rate hike since July and fifth since summer 2017.

The interest rate hasn’t been above 1.5% since December 2008. At that time, during the financial crisis, the bank made a 0.75% cut to the benchmark, bringing it to 1.5% from 2.25%.

Last month, the bank left the rate unchanged, and senior deputy governor Carolyn Wilkins later said the unknown consequences of trade talks—as well as the tit-for-tat tariff dispute—were front-and-centre in the decision.

Today, the bank’s tone was more hawkish. It noted in a press release that the new U.S.-Mexico-Canada Agreement had reduced trade policy uncertainty, which had been an “important curb” on business confidence and investment. Reflecting in part the trade deal, the bank revised projections for business investment and exports upward.

Referring to a relatively steep yield curve, the October Monetary Policy Report says long-term bond yields are well above short-term yields—a positive for the economic outlook. It added that inverted yield curves are less indicative of a recession in Canada relative to the U.S., likely due to the strong influence of global factors on Canadian long-term yields.

Still, ongoing economic challenges remain, the central bank said, including Canada’s competitiveness relative to the U.S.

For global growth, the central bank cited U.S.-China trade conflicts as a key risk, though global growth projections are little changed from the previous MPR published in July. Global growth projections for 2018 and 2019 are 3.8% and 3.4%, respectively, compared to 3.8% and 3.5%.

Though the economic outlook is solid overall, the latest report from the central bank recognizes the return of financial market volatility and stress in emerging markets. That’s because global financial conditions are becoming less accommodative as advanced economies remove monetary policy stimulus.

As a result, more balancing across asset classes could occur, says the MPR. It also notes that emerging market economies are vulnerable to tighter global liquidity given they have elevated debt levels denominated in U.S. dollars.

Growth and rate outlook

The Canadian economy continues to operate close to potential, and growth composition is more balanced, says the MPR. For example, a positive sign is demand is shifting toward business investment and exports and away from consumption and housing.

Even so, consumption is expected to grow at a healthy pace, supported by rising wages.

Real GDP is projected to grow 2.1% this year and next, before slowing to 1.9% in 2020. Previous projections from July were similar at 2%, 2.2% and 1.9% for 2018, 2019 and 2020, respectively.

The BoC expects core inflation measures to remain at about 2%, in line with an economy operating at capacity. Recent increases in inflation are attributable to temporary factors, such as airline fairs, it says.

The MPR also says the effects of cannabis legalization on monetary policy (i.e., the economy) are likely to be small.

Two key factors monitored by the central bank, household indebtedness and housing activity, are “moderate” and “stabilizing,” respectively, said the central bank in a release. “As a result, household vulnerabilities are edging lower in a number of respects, although they remain elevated.”

Notably, the central bank removed the word “gradual” from its outlook for further hikes—a way to clarify that the pace of hikes isn’t pre-ordained, senior deputy governor Wilkins said during a press conference.

That removal and today’s more hawkish tone will likely be interpreted by markets, which the economic data don’t warrant, said CIBC chief economist Avery Shenfeld in a report. He’s less optimistic for consumer spending, which he expects will decelerate. He also expects residential investment to be negative for growth in 2019, relative to a slightly positive growth impetus from the central bank.

“The central bankers see the need to slow growth by a single decimal place to 1.9% by 2020 to contain inflation. So where’s the case for a lot more rate hikes ahead?” he said in the report.

In emailed commentary, he added, “The tone today will push yields higher and be bullish for the [Canadian dollar].” He isn’t changing his call for one more hike this year, in December.

For more economic details, read the monetary policy report. For more commentary from Shenfeld, read the CIBC report.

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Staff, with files from The Canadian Press

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