BoC holds key rate at 1.25%, but hints at hikes to come

The Bank of Canada kept its key interest rate target on hold Wednesday, but hinted that rate hikes could be coming as it noted the Canadian economy was a little stronger than expected in the first quarter.

The central bank held its target for the overnight rate—a key financial benchmark that influences the prime lending rates at the country’s big banks—steady at 1.25%.

“Exports of goods were more robust than forecast, and data on imports of machinery and equipment suggest continued recovery in investment,” the Bank of Canada said in a statement.

Read: Loonie could drop to nearly US$0.70 if export woes continue: report

“Housing resale activity has remained soft into the second quarter, as the housing market continues to adjust to new mortgage guidelines and higher borrowing rates. Going forward, solid labour income growth supports the expectation that housing activity will pick up and consumption will continue to contribute importantly to growth in 2018.”

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The central bank also said global economic activity remains broadly on track, but added that ongoing uncertainty about trade policies is dampening global business investment, and stresses are developing in some emerging market economies.

It noted that recent developments have reinforced its view that higher rates will be warranted to keep inflation near its target, but added that it will take a gradual approach and be guided by the economic data.

“In particular, the bank will continue to assess the economy’s sensitivity to interest rate movements and the evolution of economic capacity,” it said.

Economists had predicted the Bank of Canada would keep its key rate on hold Wednesday, but many have suggested the rate may be headed higher later this year.

In emailed commentary to clients, CIBC director and senior economist Royce Mendes says the central bank appears more comfortable with tightening policy in the coming months. For example, the bank dropped the words “over time” after indicating that higher rates would be warranted, he notes.

However, in stressing a gradual pace of tighter policy, a July rate hike could be the central bank’s final move for this year, suggests Mendes.

“As the Bank contends with trade uncertainties, competitiveness issues and a shaky housing market, we’re sticking to our forecast that Governor Poloz moves once more in July before taking an extended break,” says Mendes.

The central bank’s decision to keep its trend-setting rate on hold came as inflation sits above the 2% midpoint of its target range of 1% to 3%, and core inflation has crept past the 2% mark for the first time since 2012.

It noted that inflation will likely be a bit higher in the near term than was forecast in its April monetary policy report due to recent increases in gasoline prices, but that it will look through the transitory impact of the fluctuations at the pump. Overlooking a slight overshoot in inflation further supports Mendes’ forecast for only one more hike this year.

As for today’s announcement moving markets, Mendes says, “The Canadian dollar is stronger on the day, given the hints at a near-term hike, which was only partially priced into markets.”

Read: What’s weighing on the loonie

The central bank has raised its key rate three times since last summer, increases that have prompted the big Canadian banks to raise their prime rates, which are used to set the rates charged for variable-rate mortgages and other variable-rate loans.

Its next scheduled interest rate decision is set for July 11 when it will also update its outlook for the economy and inflation in its monetary policy report.

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