BANK OF CANADA HOLDS RATE, BUT PROVIDES CLUES.

Stephen Poloz holds rates at May meeting but gives strong clues to a possible July hike

The Bank of Canada is on the verge of raising interest rates.

It balked at doing so this week, electing to leave the benchmark rate at 1.25 per cent for the third consecutive policy meeting. But Governor Stephen Poloz and his lieutenants on the Governing Council used their latest policy statement to disperse several clues that they are ready to move borrowing costs higher, probably when they next gather in July.

Gone is any reference to the central bank needing to be “cautious” about raising interest rates: policy makers now say they will take a “gradual” approach. The governing council also dropped a reference to higher interest rates being needed “over time.” It also emphasized that recent evidence hardens its view that higher borrowing costs will be needed to contain inflation.

“Developments since April further reinforce governing council’s view that higher interest rates will be warranted to keep inflation near target,” the central bank said. “Governing council will take a gradual approach to policy adjustments, guided by incoming data. In particular, the bank will continue to assess the economy’s sensitivity to interest rate movements and the evolution of economic capacity.”

The central bank’s next formal opportunity to adjust interest rates is July 11.

Some will wonder what stopped the Bank of Canada from raising interest rates today. It does seem likely that policy makers struggled with the decision, as they had little bad to say about the economy.

“Activity in the first quarter appears to have been a little stronger than projected,” the central bank said.

“Exports of goods were more robust than forecast, and data on imports of machinery and equipment suggest continued recovery in investment.”

The reason for the delay is the same as it’s been since the start of the year: U.S. President Donald Trump. Canada’s central bank remains concerned that U.S. trade-and-tax policy will weigh on Canadian business investment, so much so that it is prepared to risk a little inflation by waiting for more clarity.

Recent instability in a handful of big emerging economies such as Argentina and Turkey also provided reason for pause.

“Ongoing uncertainty about trade policies is dampening global business investment and stresses are developing in some emerging market economies,” the central bank said.

The situation could become clearer as soon as May 31 when Statistics Canada releases its tally of gross domestic product in the first quarter.

The report will include figures on business investment and exports of services, key data that StatCan only publishes quarterly. Strong readings on each would suggest that Canadian companies are coping with the uncertainty associated with Trump, and taking advantage of surging global demand for goods and services.

Few thought the central bank would raise interest rates on May 30.

Poloz had been clear that he was comfortable with inflation running a little faster than the target rate of 2 per cent.

He also said last month that hard evidence on investment would be a crucial variable and no such information has yet been published.

The outlook for investment is crucial because everything else the central bank cares about suggests the economy can handle higher borrowing costs.

Inflation is hovering around the 2-per-cent target, “consistent with an economy operation close to potential,” or about as fast as it can grow without putting upward pressure on prices, the central bank said.

The statement mentioned weaker home sales, but policy-makers expressed confidence that strong employment and rising wages would underpin demand for houses.

“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,” the statement said.

The central bank had been wary that its three interest-rate increases since last summer would choke domestic spending. But households seem to be coping just fine, which means the Bank of Canada can resume pushing interest rates higher.