Canada’s Third 25-Basis Point Central Bank Rate Hike in Six Months

January 17, 2018

The Bank of Canada’s Monetary Policy Council raised the overnight interest rate target to 1.25% from 1.0% today, following similar moves last September and July. A released statement revised upward projected GDP growth in 2018 and 2019 by 0.1 percentage point each to 2.2% and 1.6%. Growth has been led by domestic demand, whereas exports have expanded less quickly than assumed.

NAFTA uncertainties have been a growth depressant and continue to represent the dominant risk to the bank’s forecast. An accompanying quarterly Monetary Policy Report candidly professes that officials do not know the fate of that trade treaty with the United States and Mexico. While NAFTA features prominently in the Council’s assessment of possible risks, baseline forecasts assumed that it will not get scrapped. Some other assertions in the Policy Report are as follows. Absorption of labor market slack has proceeded faster than expected, but the acceleration of wages has not been as pronounced as one typically would expect. Potential GDP growth — the speed limit beyond which inflation can be expected to rise in an economy operating at full capacity — was revised up 0.1 percentage point to 1.6% on average in 2018-19.

Inflation is now close to the 2.0% target and projected to stay in the target’s vicinity during the forecast horizon. To wit, projected CPI inflation in 2018 was revised up to 2.0% from 1.7% predicted back in October. Now, like then, officials predict a 2.1% CPI rise in 2019.

The Council statement’s concluding paragraph dealing with forward interest rate policy guidance signals a baseline outlook in which more rate increases can be expected to occur but stresses that financial conditions should continue to be accommodative overall for some time longer.

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.

Today’s third increase in the space of six months in the Canadian central bank interest rate target lifts such to a new post-Great Recession high. Three early 25-basis point increases enacted in June, July and September of 2010 had established the previous high for the move of 1.0%. But as was the case with many other central banks that tried to normalize rates too soon, Canada’s economy struggled to tolerate the rate increases. Two of the three moves from 2010 were reversed in January and July of 2015 when the country experienced a brief recession.

Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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