‘Good news’ rate hike a sign economy is strong
Economists forecast more increases amid growing confidence in economy
The Bank of Canada raised its benchmark interest rate for the first time in seven years on Wednesday, and it did so with such an upbeat description of the economy that private sector analysts expect the bank to raise rates yet again later this year.
The Bank of Canada raised the target for its trendsetting overnight rate to 0.75 per cent from 0.5 per cent. It was the first ratehike since September 2010, and it happened because economic performance so far this year has been stronger than the bank had originally expected.
“The accumulation of evidence and the growth in our confidence that the economy is on a solid trajectory should be good news for everybody,” said Stephen Poloz, governor of the Bank of Canada. “I know not everybody will think a higher interest rate is good news, but it’s a symptom of an improving economy.”
The impact of the interest rate increase was immediate. All five of the big banks raised their prime lending rates Wednesday by 25 basis points to 2.95 per cent from 2.70 per cent. The loonie was trading at US78.52 cents mid-afternoon on Wednesday — more than a full cent above Tuesday’s price of US77.40 cents.
The last time the bank changed rates in any direction was two years ago when it brought the rate down to 0.5 per cent to help the country absorb the shock of a drop in oil prices. Much to its surprise, the economy has revved up faster than the bank expected it would. Canada now has the fastest growing economy in the G7. Poloz told reporters Wednesday the bank is confident the economy is strong enough to adapt to the 25-basispoint rate hike.
“The economy can handle very well this move,” Poloz said. “You need to preface that with an acknowledgment that, of course, interest rates are still very low.”
While the bank has confidence in its current outlook, it hasn’t mapped out a plan to continue raising rates in the coming months, Poloz said. “In the full course of time, I don’t doubt that interest rates will move higher, but there’s no pre-determined path in mind at this stage. It’s a data dependent, quarter-by-quarter analysis that we’ll be doing.”
Private sector economists said the bank’s upbeat outlook is positive enough to suggest future rate hikes are on the way.
“While the next steps obviously depend on the growth and inflation data in coming weeks, and oil prices, we would expect the next rate hike in October (with a morethan-slim chance of September),” said Douglas Porter, chief economist with BMO Financial Group, in a note.
BMO expects further modest rate increases next year, he added. “For now, we remain comfortable with looking for a 1.50 per cent overnight rate by end-2018.”
“We believe that another rate hike is likely at the Bank of Canada’s October monetary policy decision, but a slightly slower pace of one 25-basis-point hike every six months or so is likely thereafter,” said Brian DePratto, senior economist with TD.
In its quarterly Monetary Policy Report, also released on Wednesday, the bank said it expects gross domestic product to grow 2.8 per cent, up from its April forecast of 2.6 per cent.
Several risks to the economy remain, among them low global oil prices and uncertainty over the impact that future U.S. policies might have on business. But the positives outweigh those risks. Consumers are spending more, businesses are starting to invest, and exports are increasing, the bank said. “Growth is also broadening across regions and sectors, with more than twothirds of industries expanding,” the report said.
Things will slow down to two per cent next year, and 1.6 per cent in 2019, the bank added.
The Bank of Canada’s mandate is to keep inflation in check. On that score, the interest rate increase comes at an odd moment. The inflation rate for May was only 1.3 per cent, which is well below the bank’s two per cent target.
Poloz said the economy has enough momentum for inflation to approach its two per cent target next year. The bank needs to move now to stay ahead of the game, because Poloz said it usually takes more than a year for the bank’s policy measures to work their way through the economy.
“We need to be targeting inflation in the future. It’s about where we expect inflation to be because any action we take today is only going to have its full effect on inflation over the next 18 to 24 months,” Poloz said.
I know not everybody will think a higher interest rate is good news, but it’s a symptom of an improving economy.