The Bank of Canada today increased its target for the overnight rate to 1 1/4 per cent. The Bank Rate is correspondingly 1 1/2 per cent and the deposit rate is 1 per cent. Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity. However, uncertainty surrounding the future of the North American Free Trade Agreement (NAFTA) is clouding the economic outlook.
The global economy continues to strengthen, with growth expected to average 3 1/2 per cent over the projection horizon. Growth in advanced economies is projected to be stronger than in the Bank’s October Monetary Policy Report (MPR). In particular, there are signs of increasing momentum in the US economy, which will be boosted further by recent tax changes. Global commodity prices are higher, although the benefits to Canada are being diluted by wider spreads between benchmark world and Canadian oil prices.
In Canada, real GDP growth is expected to slow to 2.2 per cent in 2018 and 1.6 per cent in 2019, following an estimated 3.0 per cent in 2017. Growth is expected to remain above potential through the first quarter of 2018 and then slow to a rate close to potential for the rest of the projection horizon.
Consumption and residential investment have been stronger than anticipated, reflecting strong employment growth. Business investment has been increasing at a solid pace, and investment intentions remain positive. Exports have been weaker than expected although, apart from cross-border shifts in automotive production, there have been positive signs in most other categories.
Looking forward, consumption and residential investment are expected to contribute less to growth, given higher interest rates and new mortgage guidelines, while business investment and exports are expected to contribute more. The Bank’s outlook takes into account a small benefit to Canada’s economy from stronger US demand arising from recent tax changes. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.
The Bank continues to monitor the extent to which strong demand is boosting potential, creating room for more non-inflationary expansion. In this respect, capital investment, firm creation, labour force participation, and hours worked are all showing promising signs. Recent data show that labour market slack is being absorbed more quickly than anticipated. Wages have picked up but are rising by less than would be typical in the absence of labour market slack.
In this context, inflation is close to 2 per cent and core measures of inflation have edged up, consistent with diminishing slack in the economy. The Bank expects CPI inflation to fluctuate in the months ahead as various temporary factors (including gasoline and electricity prices) unwind. Looking through these temporary factors, inflation is expected to remain close to 2 per cent over the projection horizon.
While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target. Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.
Information note
The next scheduled date for announcing the overnight rate target is March 7, 2018. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR on April 18, 2018.
OTTAWA — The economy’s impressive run has prompted another interest-rate hike from the Bank of Canada — but looking ahead it warned of the broadening negative impact of NAFTA’s uncertain future.
The central bank pointed to unexpectedly solid economic numbers as key drivers behind its decision Wednesday to hike the trend-setting rate to 1.25 per cent, up from one per cent. It was the bank’s third increase since last summer, following hikes in July and September.
While the central bank signalled more rate increases are likely over time, it highlighted the growing, negative impacts related to the unknown outcome of the renegotiation of the North American Free Trade Agreement.
The bank not only made a point of emphasizing the potential negative effects on trade, but also the impacts on business investment in Canada.
Moving forward, the bank said “some continued monetary policy accommodation will likely be needed” to keep the economy operating close to its full potential. The bank said it would also remain cautious when considering future hikes by assessing incoming data such as the economy’s sensitivity to the higher borrowing rates.
Most of Canada’s big banks raised their own prime rates following the announcement.
For Wednesday’s move, the bank couldn’t ignore the encouraging late-2017 data, even as it acknowledged the NAFTA-related risks.
Governor Stephen Poloz stressed during a news conference that the bank remains data dependent, although he conceded a rate hike wasn’t a “no-brainer” this time around.
“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 some research has found that 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’s latest monetary policy report, also released Wednesday, said that trade-policy uncertainty is expected to lower investment by two per cent by the end of 2019. The report also said new, or “greenfield,” foreign direct investment into Canada has fallen since mid-2016 — a possible impact of the trade uncertainty.
The Bank of Canada warned that lower corporate taxes in the U.S. could encourage firms to redirect some of their business investments south of the border. On the other hand, it predicted Canada to see a small benefit from the recent U.S. tax changes, thanks to increased demand.
In explaining the hike, the bank said in a statement that inflation was close to target and the economy was operating roughly at capacity. It also said consumption and residential investment had been stronger than anticipated, reflecting healthy employment growth.
“Business investment has been increasing at a solid pace, and investment intentions remain positive,” the bank said.
Moving forward, the bank predicted household spending and investment to 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.
Exports have been weaker than anticipated, but are still expected to contribute a larger share of Canada’s growth, the bank said. It also noted that government infrastructure spending has helped lift economic activity.
“Today’s rate hike was a rear-view mirror move, but the Bank of Canada hints that the view out the front window isn’t quite as sunny,” CIBC chief economist Avery Shenfeld wrote in a research note to clients after the rate announcement.
“We share the Bank of Canada’s view that higher rates will be needed over time. But perhaps not as fast and furious as the market was starting to think. The bank’s statement put NAFTA uncertainties right up front.”
The bank also released new economic projections Wednesday in its latest monetary policy report.
For 2017, it’s now predicting three per cent growth, as measured by real gross domestic product, compared with its 3.1 per cent prediction in October.
The bank slightly increased its predictions for 2018, up to 2.2 per cent from 2.1 per cent. It expects the economy to expand by 1.6 per cent in 2019, up from its previous call of 1.5 per cent.
The fourth quarter of 2017 and the first quarter of 2018 are each expected to see annualized growth of 2.5 per cent.
Poloz raised rates in July and September in response to a surprisingly strong economic run that began in late 2016. The hikes took back the two rate cuts he introduced in 2015 to help cushion, and stimulate, the economy from the collapse in oil prices.
Up until a couple of weeks ago, many forecasters still had doubts that Poloz would raise the rate Wednesday. However, two strong reports — the December jobs data and the bank’s business outlook survey — led many experts to change their calls.
The Bank of Canada (BoC) raised its trend-setting interest rate to 1.25 per cent on Wednesday, marking the third 0.25 percentage point increase since July and the first time the rate rose above 1 per cent in nine years.
READ MORE: Staggering share of Canadians fear bankruptcy if interest rates rise much more
The move matches the expectations of most economists and investors, who had been anticipating another hike after two consecutive blockbuster jobs reports for November and December. The economy churned out just under 160,000 net new jobs over the last two months of 2017, pushing Canada’s unemployment rate to 5.7 per cent, the lowest level since comparable record-keeping began in 1976.
WATCH: Bank of Canada announces interest rate hike
READ MORE: Canada’s unemployment rate falls to lowest rate in over 40 years: StatCan
The central bank’s own survey of Canadian companies added more fodder for a rate increase. The so-called Business Outlook Survey, a closely watched barometer of business sentiment in this country, sounded an upbeat note last week, showing that companies across the country are feeling optimistic about the future and have plans to boost both investment and hiring.
READ MORE: Mortgage calculator: See how rising interest rates affect your payments
Still, the BoC struck a cautious note in the statement accompanying its interest rate announcement. Despite an expected “small benefit” to the Canadian economy from strong growth in the U.S., concerns about the future of NAFTA continue to weigh on Canada’s economic outlook, it warned.
WATCH: Vulnerability to economic ‘shocks’ has grown in Canada
Consumer spending and the housing market are also expected to contribute less to growth as a result of higher interest rates and stricter mortgage rules, the bank said.
Although the BoC indicated that its key policy rate might climb further, there was “no indication of the pace at which it will increase,” said Steve Ambler, David Dodge Chair in Monetary Policy at the C.D. Howe Institute.
The central bank also noted that wages are rising at a slower pace than “would be typical” in a labour market as tight as the current one.
WATCH: What is an interest rate?
Despite robust economic growth, subdued wage growth might limit the extent to which inflation will rise, giving the central bank latitude to proceed slowly on further rate increases, said Ambler.
Although investors expect two more rate increases of 0.25 percentage points each by the end of the year, “I would be surprised if [the BoC] had two [hikes] in a row,” said Ambler.
The BoC’s next interest rate announcement is March 1.
The central bank also offered updated economic projections in its Monetary Policy Report.
Canada's biggest lenders have raised their prime lending rates on the same day the country's central bank moved its benchmark interest rate a quarter percentage point higher.
The Bank of Canada raised its key lending rate by a quarter point to 1.25 per cent Wednesday morning, the third time it has moved its benchmark rate from once-record lows last summer.
The bank rate has an impact what Canadians pay lenders for things like mortgages and personal loans. While the move means borrowers can expect to pay more, savers can expect to earn more, too, on savings accounts and guaranteed investment certificates.
That's exactly what happened later on Wednesday afternoon, when Canada's five biggest banks — Royal, TD, CIBC, BMO and Scotiabank — all hiked their own prime lending rates by a quarter percentage point, effective tomorrow.
As of Thursday, Jan. 18, all five now have the same prime lending rate of 3.45 per cent. Prior to the Bank of Canada's move, their rates were all 3.2 per cent.
The central bank was widely expected to raise its rate after data in recent months showed gross domestic product growing, the job market healthy and the cost of living ticking higher.
The bank's benchmark rate is now at its highest level since 2009.
In the MPR, the bank nudged up its expectations for how the economy will perform this year and next. The bank now expects Canada's economy to expand by 2.2 per cent this year and 1.6 per cent in 2019. Previously the bank was anticipating 2.1 and 1.5 per cent growth.
But while broadly positive about the economy's prospects, the bank cited "uncertainty about the future of NAFTA" as a reason for concern moving forward.
Rate hikes from the central bank can add up fast for Canadians with variable rate mortgages. (Scott Galley/CBC)
Officials from Canada, the United States and Mexico are set to meet again to discuss trade issues next week, and there are concerns that the U.S. is getting ready to unilaterally pull out of the North American Free Trade Agreement — a development that would hit Canadian exports hard.
"At this stage, it is difficult to predict the possible outcomes of trade negotiations and the timing, incidence and magnitude of their effects," the bank said in its MPR, which mentions NAFTA concerns nine times in the 21-page document.
At a press conference, Bank of Canada governor Stephen Poloz expanded on that thought, telling reporters it is hard to come up with a firm number to gauge the impact of something as dramatic as implementing tariffs into a trade relationship that had previously been open.
"I believe it would be net negative for both Canada and for the U.S.," he said of the theoretical demise of NAFTA, "but to actually quantify that is very difficult, because every sector is affected differently."
Reaction to the rate move was muted, as the decision was very much expected. But dark clouds on the trade horizon had many watchers downgrading their expectations.
"Today's rate hike was a rear-view mirror move," CIBC economist Avery Shenfeld said of the bank's decision to hike, but the concern over NAFTA "hints that the view out the front window isn't quite as sunny." At the very least, he said, the statement reinforces "the need to be cautious in how fast they hike ahead."
Economist Frances Donald with Manulife agrees with that assessment, telling CBC News in an interview that while the market was expecting as many as three hikes this year, the situation is fluid.
"If we continue to see those NAFTA related uncertainties," Donald said, "and if we see some downsides to the economy from new mortgage rules that came in or from potentially the increase in minimum wages then we'll probably be a Bank of Canada that needs to go more slowly."
"But as long as the data continues to come in as it's been doing, steadily improving" she said, "we are going to see more rate hikes."
How a rate hike will affect your mortgage
This calculator takes your current mortgage rate, and assumes it will rise by 0.25 per cent to match the recent hike from Canada's central bank. If that happens:
