Interest rate hiked despite NAFTA question
OTTAWA — The economy’s impressive run prompted the Bank of Canada to raise its trend-setting interest rate Wednesday for the third time since last summer — but looking ahead it warned of growing uncertainties about NAFTA.
The central bank pointed to unexpectedly solid economic numbers as key drivers behind its decision to hike the rate to 1.25 per cent, up from one per cent. The increase followed hikes in July and September.
While the central bank signalled more rate increases are likely over time, it noted the unknowns surrounding the future of the North American Free Trade Agreement — and the potential negatives for Canada — were casting a widening shadow over its outlook.
The bank said “some continued monetary policy accommodation will likely be needed” to keep the economy operating close to its full potential.
Governing council, the bank added, would remain cautious when considering future hikes by assessing incoming data such as the economy’s sensitivity to the higher borrowing rates. The statement raised questions about how quickly the bank will raise the rate from here.
Royal Bank of Canada and BMO Bank of Montreal were first among Canada’s banks to respond to the rate hike, raising their prime lending rate by a quarter of a percentage point, to 3.45 per cent, effective Thursday. Other banks are expected to make similar moves.
For Wednesday’s move, the central bank couldn’t ignore the encouraging late-2017 data, even as it acknowledged the risks about NAFTA’s renegotiation.
Governor Stephen Poloz stressed during a news conference that the bank remains data dependent, although he conceded that a rate hike wasn’t a “no-brainer” this time around because of the NAFTA talks.
“Of course, the big cloud over the forecast as well as our discussion is, well, NAFTA,” Poloz said.
“How immediate? How big? Lots of debate around that. Given those uncertainties, of course, the possibility of not moving (the rate) this time was in the air.”
In particular, Poloz noted that research has argued the trade impacts of the deal’s demise might not have such a major impact on Canada. However, he stressed that the end of NAFTA would likely take a big bite out of investment in Canada.
“We can’t just relax and assume that it would be a small shock,” he said.
The bank predicted household spending and investment will gradually contribute less to economic growth, given the higher interest rates and stricter mortgage rules. It predicted Canada’s high levels of household debt would amplify the effects of higher interest rates on consumption.