Bank of Canada increases its key interest rate to 1.5%
Fourth hike in a year pushes rate to highest level since 2008, signalling strong economy
OTTAWA— Undaunted by expanding trade risks, the Bank of Canada governor Stephen Poloz raised the interest rate Wednesday and signalled the economy’s resilience is keeping him on a hiking trajectory.
The quarter-point increase, the central bank’s first move in six months, brought the rate to 1.5 per cent. It was Poloz’s fourth hike over the past 12 months and marked the first time the rate has been this high since December 2008.
The decision, a move that prompted some of the big banks to start raising their prime rates later in the day, arrived in the middle of a trade dispute between Canada and the United States that’s expected to hurt both economies.
Poloz made the call even though he warned the economy should brace for larger impacts from mounting trade uncertainty. In particular, the trade impacts were caused by the Trump administration’s recent steel and aluminum tariffs on Canada and, in response, Ottawa’s retaliatory duties on U.S. imports.
The tariff fight is expected to shave two-thirds of a percentage from Canada’s economic growth by the end of 2020, the bank estimated.
Poloz said despite the combined effects of the metals levies, and earlier U.S. tariffs on products like softwood lumber, the bank still projects Canadian growth to average a promising level of 2 per cent over the next few years, just slightly above its potential and with inflation already on target.
The bank expects the negative blow of the trade policies to be largely offset by higher oil prices and the stronger U.S. economy — both of which, on balance, will benefit Canada.
The Bank of Canada is also predicting exports and business investment, which were stronger than expected in the first three months of the year, to churn out bigger contributions to growth. It also expects household spending to make up a smaller share of overall growth due to the dampening effects of higher interest rates and stricter mortgage rules.
“It’s evident to us that higher interest rates will be warranted.” STEPHEN POLOZ BANK OF CANADA GOVERNOR
With the positive outlook, Poloz expects interest rates to continue along their cautious, upward path.
“It’s evident to us that higher interest rates will be warranted, but of course we’re not in a position to say exactly how much higher or at what rate we might get there,” Poloz told a news conference Wednesday in Ottawa.
Poloz stressed the bank will continue with its gradual, datadependent approach as it moves toward its neutral rate, which his team has pegged between 2.5 and 3.5 per cent.
Along the way, the bank will have to keep close watch on another trade-related unknown that many believe would inflict far more damage on the economy: U.S. duties on the automotive sector.
U.S. President Donald Trump has threatened to slap tariffs on the auto sector, which is made up of highly integrated, crossborder supply chains. The Bank of Canada warned that auto levies would have “large impacts on investment and employment.”
The bank, however, didn’t quantify the possible effects of auto tariffs on Wednesday.
For one, Poloz said the bank can’t make policy decisions based on “hypothetical scenarios.” He added that the unknowns around trade could also include positive developments such as the successful re- negotiation of the North American Free Trade Agreement over the coming months.
“We need to base our decision on what we actually know,” he said.
In addition to tariffs, Canadian businesses must also contend with the uncertainty surrounding the stalled talks on NAFTA’s renegotiation.
Outside the country, the Bank of Canada has its eye on how widening global trade disputes, including an intensifying battle between the U.S. and China, will affect the world’s economy. It warns that “escalating trade tensions pose considerable risks to the outlook” at the global level.
Even with the trade issues, the Bank of Canada is predicting slightly stronger growth for Canada over the next couple of years, according to updated projections released Wednesday in its quarterly monetary policy report.
It expects real gross domestic product to grow 2.2 per cent in 2019, up from its April call of 2.1 per cent, and by 1.9 per cent in 2020, compared with its previ- ous prediction of 1.8 per cent. The economy’s growth projection for this year remains at two per cent, the bank said.
Many economists anticipate several more hikes this year and in 2019.
TD senior economist Brian DePratto wrote in a note to clients Wednesday that the messaging is consistent with a central bank that’s “committed to a rate hike cycle, but leaves sufficient room to adjust to evolving events.”
National Bank of Canada experts wrote in a note that Poloz may choose to err on the side of caution when it comes to future hikes because of threats of auto tariffs, which they warned, if applied, would have “unambiguously devastating economic impacts,” particularly in Ontario.
Leading up to the announcement, Poloz was widely expected to raise the interest rate following a run of encouraging economic numbers, including the Bank of Canada’s own survey on business sentiment, still-solid job markets and growth in wages.