First Bank of Canada Policy Interest Rate Hike Since September 2010

July 12, 2017

In the initial emergence from the Great Recession, the Bank of Canada raised interest rates three times while the Fed stood pat, lifting the overnight policy rate by 25 basis points each in June, July and September 2010. Like many central banks that jumped the gun, part of that tightening proved premature and had to be reversed later. The rate was cut by 25 bps in January 2015 and again by that amount six months later. The overnight rate had been at 0.50% since September 2015 but now becomes 0.75%.

Today’s rate hike is explained in a released statement and supplemented by a newly published quarterly Monetary Policy Report. A tightening had been hinted by Governor Poloz two weeks ago, who then spoke of unused capacity getting trimmed more steadily, and this greatly reduced the element of surprise at today’s news. That said, the justification for acting now is not all that compelling because it rests on a revised forecast of slightly faster growth and an assumption that recently lower inflation will turn out to be temporary.

  • Real GDP is now projected to grow 2.8% this year instead of 2.6% assumed in the previous forecast made three months ago. GDP slows to 2.0% in 2018 instead of 1.9% assumed before but then to 1.6% instead of 1.7% in 2019, which would be below target. Canadian monetary officials also assume marginally faster global growth in 2017 than they did before, but such stays at that same pace in the ensuing two years instead of accelerating gradually as the previous forecast thought. The uptick in projected growth near term is enough to eliminate excess capacity by the end of this year instead of sometime early in 2018 as assumed before. Note, forecasts of economic growth are always getting modified. Suppose, for example, that a big trade war erupts, provoked by Canada’s main trade partner. Then all bets will be off. Or likewise, suppose the price of oil declines under $40.
  • The drop in inflation this year, by contrast, is a real fact. Bank officials dismiss such to an extent because they presume that lower consumer energy and motor vehicle prices are a temporary development. However, the drop in inflation also reflects an understandable possible downward drift of expected inflation after years in which inflation everywhere has turned out to be lower than assumed. And it has been dominated by commodities like oil, whose prices could as easily slide further as turn upward.

So what’s really going on? I think that like policymakers at the Fed, Canadian monetary officials feel an increasing urgency to raise interest rates in order to create scope to react when the business cycle eventually turns. And this desire is compounded by uneasiness that ultra-low interest rates are fanning an asset bubble. Canada’s housing market has been overheated.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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