Canada: Bank of Canada hikes policy rate by 25 basis points in July, opens the door to tightening cycle
July 12, 2017
On 12 July, the Bank of Canada (BoC) raised its target for the overnight rate by 25 basis points to 0.75% in what was the Bank’s first rate hike in seven years. The Bank’s decision, unthinkable only months ago when the economy was still struggling to gather momentum, was widely expected by analysts following weeks of statements by officials—including Governor Stephen Poloz—that hinted at the possibility of an incoming rate hike due to improved economic conditions. Along with the decision to hike rates, the Bank also upwardly revised its GDP forecast for 2017 to 2.8% (previously reported: +2.6%) and its GDP forecast for 2018 to 2.0% (previously reported: +1.9%).
Robust household spending fueled the BoC’s about-face to hike rates as consumers’ stellar performance in Q1 absorbed a significant amount of the remaining slack in the economy. The positive momentum was further confirmed with the 30 June release of April’s strong GDP print. Moreover, underpinning healthy spending so far this year have been steady upticks in employment and real wages, which suggest there is declining excess capacity in the economy. Economic growth has broadened across industries and regions, suggesting that further growth this year will be sustainable in the absence of monetary stimulus. Further pressure to bring forward the onset of the Bank’s long-expected tightening cycle was applied by the fully-recovered energy sector and an economy more fully-adjusted to lower oil prices, having put the oil shock firmly in the rearview in recent months.
Pressure to raise rates increased in recent months as worsening housing market dynamics—especially in Toronto and Vancouver—risk an outsized correction. Although recent policy measures to rein in mortgage lending have kept debt profiles broadly sustainable, sky-high consumer debt levels have continued inching up and, at 167% of disposable income, they remain the highest among the G7 economies. Despite Poloz’s clear statements that raising rates was not seen by the Bank as an effective mechanism to curb the overheated housing market, the move is likely to initiate some cooling-off in asset prices.
In its statement, the BoC acknowledged that inflation, by every measure, has been stubbornly low but argued that temporary factors were to blame for the softness. With that, the Bank charged that inflation would return to the 2.0% midpoint of the target range by mid-2018 as these factors fade. Looking ahead, the Bank struck a hawkish tone and left the door wide open for additional rate hikes later this year, although it made clear that significant challenges still faced the economy in the near term—including investment and ongoing trade disputes with the United States.
The next monetary policy announcement is scheduled for 6 September.
Author: Christopher Thomas, Economist