The Bank of Canada forged ahead with another interest rate hike in a nod to the country’s surging economy, while signaling its appetite for further tightening may be curbed by a rising Canadian dollar and sluggish inflation.
Policy makers raised their benchmark rate for a second time since July, by 25 basis points to 1 percent. At the same time, they cited risks including continued excess capacity, subdued wage and price pressures, geopolitics and the higher Canadian dollar, along with worries about the impact of rising interest rates on highly indebted households.
“Future monetary policy decisions are not predetermined and will be guided by incoming economic data and financial market developments as they inform the outlook for inflation,” the Bank of Canada said Wednesday in a statement from Ottawa.
Governor Stephen Poloz is trying to strike a balance between bringing interest rates back to more normal levels amid the strongest
growth spurt in more than a decade, and acknowledging the persistence oflow inflation and subdued wage pressures. He may also be attempting to restrain market expectations it will get too far ahead of the Federal Reserve.
Futures trading suggests investors were anticipating — before Wednesday’s rate decision — as many as three hikes from the Bank of Canada by the end of 2018, versus one more for the Federal Reserve. Only five of 26 economists surveyed by Bloomberg News expected the central bank to hike its benchmark rate. Futures trading was assigning about a 40 percent chance of an increase. Another rate increase is now almost fully priced in by December.
Market Reaction
Canada’s currency climbed as much as 1.8 percent after the decision, reaching C$1.2146 against its U.S. counterpart, the highest intraday level since June 2015, and extending the gain this year to 10 percent. Bonds yields surged, with the two-year note jumping eight basis points to 1.43 percent, the highest in more than five years.
The bank didn’t repeat language from previous statements about the current degree of stimulus being appropriate, which may suggest it will stay on its tightening path.
“What they are saying to me is they are leaving the door open to future hikes,” said Derek Holt, head of capital markets economics at Bank of Nova Scotia in Toronto. He changed his forecast last week to correctly predict the rate increase.
Considerable Stimulus
The bank cited Canada’s stronger-than-expected economic performance for the hike, warranting a removal of some of the “considerable” stimulus in place. In effect, the Bank of Canada fully removed the two rate cuts from 2015, which were meant to counter the negative impact of falling commodity prices.
The Bank of Canada also cited recent better-than-expected data supports its view that growth is more “broadly-based and self-sustaining.” It also cited more “widespread strength” in business investment and exports, and “stronger-than- expected indicators of growth” globally.
Yet, there was an introduction of cautionary language in the statement, and new worries about financial market developments, that weren’t in the last rate decision and suggests the central bank isn’t quite ready to declare victory on whether the economy has totally eliminated its slack.
“There remains some excess capacity in Canada’s labor market, and wage and price pressures are still more subdued than historical relationship would suggest,” according to the statement.
The Bank of Canada said there remains “significant geopolitical risks and uncertainties” around international trade and fiscal policies that have weakened the U.S. dollar. The suggestion is the Canadian dollar gains aren’t totally reflective of growth. It was the first reference to the Canadian dollar in a rate statement since March.
The bank also said it will pay close attention to the “sensitivity” of the economy to higher interest rates given “elevated” household indebtedness, and added it will pay “particular focus” to the evolution of the economy’s potential growth rate, possibly a suggestion that the economy can run at a faster pace than the bank originally thought without triggering inflation.
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