LOONIE RISES WITH HINTS OF INTEREST RATE HIKE.
BUT INFLATION THE MISSING PIECE … … OF THE ECONOMIC PUZZLE
Canada’s long ride with rock bottom interest rates appears to be coming to an end.
Stephen Poloz, governor of the Bank of Canada, has dropped a big hint that for the first time in seven years, the bank will be pushing Canadian interest rates higher.
The loonie rallied as high as 76.71 U. S. cents on Wednesday, its highest level against the U. S. dollar since February.
In an interview broadcast on CNBC, Poloz said two interest rate cuts the Bank announced in 2015 to help Canada grapple with a drop in oil prices have done their job. Canada now has one of the fastest growing economies in the G7.
Speaking f rom a meeting of top central bankers in Portugal, Poloz said it may be t i me t o remove t he st i mulus. That could happen in less than two weeks, as the Bank’s next regularly scheduled interest rate decision is July 12. “It does look as though those cuts have done their job. We’re just approaching a new interest rate decision, so I don’t want to prejudge that, but certainly we need to be at least considering that whole situation now that capacity — excess capacity — is being used up steadily,” Poloz said.
Benjamin Reitzes, Canadian rates and macro strategist with BMO Capital Markets in Toronto, said this means a rate hike is coming on July 12. “He’s not going to give it away, but that’s a pretty strong and clear- cut signal that a July rate hike is very much on the table.”
IT DOES LOOK AS THOUGH THOSE CUTS HAVE DONE THEIR JOB
The last time the bank actually pushed rates upward was 2010, when it guided its benchmark rate up to 1.0 per cent as Canada pulled out of the 2008-2009 financial crisis. The rate remained at 1.0 per cent until early 2015, when the bank pulled its target down to 0.5 per cent to deal with the oil shock. The overnight target rate is currently just 25 basis points above the historic low of 0.25 per cent that was in place after the 2008-2009 crisis.
The jump in the loonie on Wednesday means the market thinks a rate hike is on its way soon. The loonie rises as investors from abroad move their money into Canada to benefit from rising interest rates.
Higher rates seem to be a global trend. The U.S. Federal Reserve has already begun gradually raising its rate tar- get. The Bank of England is starting to think about making its own move, while the European Central Bank has been talking about moving away from quantitative easing.
In Canada, a strong economy and a low jobless rate has led many private sector economists to note that Canada is due for some interest rate hikes. In fact, anticipation of rate hikes has made the Canadian dollar the bestperforming currency in the Group of 10. The remarks by Poloz on Tuesday show that the Bank is catching up with the market outlook.
“The Poloz comments buttress the change in tone that we’ve seen from the Bank over the past month,” said Bipan Rai, a foreign- exchange and macro strategist at Canadian Imperial Bank of Commerce.
Earlier this month, both Poloz and Senior Deputy Governor Carolyn Wilkins made public remarks that pointed in the direction of higher rates, though perhaps not immediately.
While the market has been cheering, the Bank of Canada has had its own short list of concerns. The bank wants to see Canadian exports rise, and a lower loonie certainly helps with that. Oil prices remain low, and there’s still uncertainty on how things will shake out on the trade front. Canada, Mexico and the United States launch talks in August to renegotiate the North American Free Trade Agreement.
But the Poloz interview on Tuesday strongly suggests that the bank has caught up with the bullish forecasts we’ve been seeing from the private sector.
The bank now sees the Canadian economy gathering enough steam to absorb higher interest rates. What’s more, Poloz said he is comfortable with oil prices in the range of US$ 40 to US$ 50 a barrel. And while inflation remains low, Poloz said there is enough momentum in the economy for it to pick up steam down the road.
“At long last, the Bank of Canada has acknowledged that the economy is in good shape and that the worst of the oil shock has passed, something we highlighted as early as February,” Reitzes said. “Over the past 10 months, GDP has grown at the best pace since 2010, and job gains have been the fastest since 2012. That’s driven the jobless rate to a record low in Central Canada.”
BMO expects the bank to boost its target rate by 25 basis points to 0.75 per cent on July 12, followed by a second 25-basis point hike to 1.0 per cent in January.
While it’s too early to make a firm call, if the Bank of Canada continues to sound hawkish, BMO expects rates could rise by another 50 to 75 basis points next year.