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Canada Monetary Policy July 2018

Canada: Bank of Canada hikes target for the overnight rate in July

On 11 July, the Bank of Canada (BoC) raised its target for the overnight rate by 25 basis points to 1.50%, as widely expected by market analysts. The decision to hike rates came down to solid fundamentals and on-target inflation in recent months. Although downside risks persist, especially with respect to the evolution of trade tensions with the United States and the housing market, BoC officials stressed that more rate hikes could be warranted over the short term should wage pressures—and underlying labor-market fundamentals—continue to pick up.

Inflation edged higher in recent months and the Bank still sees it climbing to 2.5% over the coming months before settling back toward the midpoint of the BoC’s 2.0% plus/minus 1.0 percentage point target by mid-next year. Along with inflation, however, wage growth has run close to 2.3%—a solid reading by all accounts but still less than would be expected with a stronger labor-market backdrop. Along with higher inflation, growth metrics suggest the economy has been running at close to capacity. Moreover, incoming data for the second quarter points to an acceleration from the outset of the year driven largely by temporary factors. Ignoring these, however, the economy is still firming; the housing market has begun to stabilize and exports have been bolstered by higher commodity prices, while non-residential investment is growing as capacity pressures stress firms. On balance, the Bank’s main concern in hiking rates in July remained household spending, as indebted consumers have been increasingly pinched by higher interest rates and—earlier this year—by new mortgage-lending rules.

Despite highlighting the serious uncertainties facing the economy, namely a brewing North American trade war and still-major imbalances in the domestic housing market, BoC officials took a hawkish stance in July as upbeat economic data left room for optimism. Analysts concluded that the BoC’s tweaked language in July’s press release indicates that further rate hikes are likely on the horizon before year-end, especially given officials’ emphasis on capacity constraints and wage growth. As it stands, a majority of FocusEconomics analysts see another rate hike in the fourth quarter and expect the pace of increases to persist into next year.

Commenting on the BoC’s decision, Brian DePratto, Senior Economist at TD Economics, noted:

“All told, today’s statement, outlook, and press conference are all consistent with a Bank that’s committed to a rate hike cycle, but leaves sufficient room to adjust to evolving events. Data dependency is the operating guideline, and it will be challenging to separate signal from noise, particularly on the trade front. […] We maintain a slightly cautious growth outlook – we still look for more hikes, but think a gradual pace of one hike roughly every two quarters still makes the most sense. NAFTA resolution and/or receding trade threats would certainly lay the ground work for an additional hike this year, but we won’t hold our breath.”

The Bank’s next monetary policy announcement is scheduled for 5 September.

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