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Canada Monetary Policy October 2018

Canada: Bank of Canada raises rates in October amid solid fundamentals

On 24 October, the Bank of Canada (BoC) raised its target for the overnight rate by 25 basis points to 1.75%, as widely expected by market analysts. Strong fundamentals and near-target inflation drove the rate hike, and officials stressed its importance as the economy operates close to potential. Along with the decision to hike rates, the Bank also revised its GDP forecast for 2018 to 2.1% (previously reported: +2.0%) and its GDP forecast for 2019 to 2.1% (previously reported: +2.2%).

Reduced uncertainty over trade with the United States in light of the newly-signed USMCA positively impacted business and consumer confidence in recent weeks, and business investment is likely to benefit over the forecast horizon. Moreover, household spending has been healthy despite higher interest rates and new mortgage lending rules; the economy is nearing full employment and wage growth is expected to pick up in the coming months. Meanwhile, inflation ticked down to 2.2% in September, and core inflation measures remained close to 2.0%. On the downside, lower commodity prices are likely to hit exports and could hinder growth prospects for some key industries.

Taken together, the Bank is committed to reaching a neutral long-term level of 2.50% to 3.50% for its target for the overnight rate. Market analysts are projecting another rate hike as soon as January and an overwhelming majority of FocusEconomics panelists expect a rate increase in Q1 of 2019. Nevertheless, wage stagnation and household debt could delay the hike if households’ respond poorly to higher borrowing costs. The Bank also highlighted the impact of the U.S.-China trade dispute on global supply chains as a potential risk to hiking rates too soon.

Commenting on the BoC’s decision, Brian DePratto, senior economist at TD Economics, noted:

“The Bank’s communication today re-affirms our view that three additional rate hikes are likely next year. […] Should rising rates begin to have an outsized (and growth-sapping) impact on spending/credit growth, we’d expect at least a pause. […] So while we think the Bank of Canada will hit ‘neutral’ by late next year, even with the change in tone today the risks to this call are skewed towards hitting the 2.50% mark later, rather than sooner.”

The Bank’s next monetary policy announcement is scheduled for 23 November.

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