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.
The Bank of Canada raised its key lending rate by a quarter percentage point to 1.25 per cent Wednesday, the third time it has moved its benchmark rate from once-record lows last summer.
The bank's rate has an impact on rates that Canadians get from retail banks for things like mortgages, savings accounts and GICs. The move means borrowers can expect to pay more, but savers can expect to earn more, too.
That's exactly what happened later on Thursday afternoon, when Canada's five biggest banks — Royal, TD, CIBC, BMO and Scotiabank — all hiked their prime lending rates by 25 points, 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 would 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, and Canada's largest bank has already moved to match the central bank's hike.
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."
Some of the bank's worries came as a negative surprise to currency investors, who sold off the loonie after the rate decision came out. Shortly after the announcement, the loonie was changing hands at just over 80 cents US, off about a half a cent from where it was before the announcement.
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:
The Bank of Canada had a window to raise interest rates and it opted to use it.
Canada’s central bank raised its lending benchmark a quarter point to 1.25 per cent, an historically low setting that nonetheless will seem high to anyone who got used to post-crisis borrowing costs that were closer to zero.
“Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity,” the Bank of Canada said in a statement summarizing its latest round of policy deliberations.
Governor Stephen Poloz wasn’t dying to make money more expensive.
In mid-December, Poloz emphasized that he thought lower borrowing costs could pull more people into the labour market and reverse an extended period of stagnant wage gains. The central bank also said it was wary of U.S. President Donald Trump’s threats to quit the North American Free Trade Agreement and how investors and executives would respond to the regular exchange of threats between the United States and North Korea.
Those factors mean Poloz and his advisers on the Governing Council have set a high bar for interest-rate increases in the near term. To emphasize that point, the central bank followed its positive assessment of the economy with a reminder of its worries about NAFTA, the future of which is “clouding the economic outlook,” policy makers said.
Still, the central bank said last year that interest rates must eventually return to higher levels to keep inflation from running out of control, and that it would lift borrowing costs when data send a clear signal. That standard had been met by the end of December, when the unemployment rate dropped to the lowest level in at least four decades.
“Recent data show that that labour market slack is being absorbed more quickly than anticipated,” the Bank of Canada said.
A recent survey of businesses also showed that executives intend to increase investment over the year ahead, despite uncertainty over trade and stability of the international order. Yet policy makers sense fragility in that sentiment. They said worries over the NAFTA are starting to paralyze decision making, and causing some money that might have been spent in Canada to end up in the United States. As a result, the central bank increased its estimate of how much economic growth will be hurt by trade uncertainty. (The central bank predicts gross domestic product will slow to 2.2 per cent in 2018 and 1.6 per cent in 2019, after expanding 3 per cent last year.)
President Donald Trump’s business tax cuts at the end of 2017 will give companies and investors another reason to choose the U.S. over Canada. The central bank assumes only a “small” benefit for Canada from the tax changes because any increase to demand for exports will be nearly offset by lost investment.
“Underlying fundamentals are strong and would support a more robust growth trajectory were it not for the effects of heightened uncertainty around trade policy and increased incentives to shift investment from Canada to the United States as a result to U.S. tax reforms,” the central bank said its latest quarterly report on the economy.
The closest observers of Canadian monetary policy saw the shift coming, albeit some sooner than others.
By last week, the chief economists at all seven of the country’s biggest were predicting a quarter-point increase. The C.D. Howe Institute’s Monetary Policy Council, a panel of academics and Bay Street analysts, said on Jan. 11 that the central bank should raise interests rates by a quarter point today, and at least twice more before the end of the year. That was a shift. At the end of November, the informal group said the Bank of Canada should wait until the spring of 2018 to raise interest rates, and then add a second quarter-point increase by the end of the year.
Predicting the next increase will be more difficult.
Some forecasters, including economists at Royal Bank of Canada, see three more quarter-point increases this year. That seems aggressive, given the Bank of Canada’s doubts about the ability of Canadian companies to compete with Trump’s America in the short term. Those concerns argue for lower interest rates, at least until the future of NAFTA is resolved.
• Email: kcarmichael@nationalpost.com | Twitter: @CarmichaelKevin
Here’s the statement from the Bank of Canada on its rate decision for Wednesday, January 17, 2018:
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.
