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Canada Monetary Policy May 2018

Canada: Bank of Canada signals forthcoming rate hike in July

On 30 May, the Bank of Canada (BoC) left its target for the overnight rate unchanged at 1.25%, as broadly expected by market analysts. The decision to hold rates unchanged came down to solid fundamentals, which appear to have kept economic growth and inflation each hovering near 2.0% in recent months. Although downside risks persist, BoC officials stressed that a rate hike could be imminent in the months ahead if uncertainty fades on key issues, including trade and the housing market.

Recent inflation metrics may not have warranted a rate hike in May, but they seem almost certain to warrant one in the months to come. Inflation has been close to the Bank’s midpoint target of 2.0% since the outset of the year, and rising fuel prices are likely to send it higher over the coming months. BoC officials stressed, however, that they would ignore transient inflationary pressures and focus on core measures, which have also been tracking close to 2.0% recently. Moreover, growth metrics appear more solid now than a month ago. In line with the Bank’s forecasts, the economy is expected to grow close to 2.0% in the first half of the year. Furthermore, according to officials, economic activity in the first quarter was “a little stronger” than first thought—largely due to firmer gains in exports than initially forecast.

Despite also highlighting the serious uncertainties facing the economy, namely a brewing North American trade war and growing imbalances in the domestic housing market, BoC officials took a more hawkish stance in May as rosier economic data left room for optimism. Analysts concluded that the removal of the words “cautious,” in terms of the pace of future rate hikes, and “over time,” indicating when higher rates would be warranted, all but confirms that a rate hike should be forthcoming in July. As it stands, a majority of FocusEconomics analysts see this year’s second rate hike in the third quarter but are more split over whether a third hike will materialize before year-end. That said, given households’ heavy indebtedness, officials will continue weighing further rate hikes against their effect on household spending—growth of which has been tapering since last year.

Commenting on the BoC’s decision, Royce Mendes, Director and Senior Economist at CIBC World Markets, noted:

“Indeed, the [30 May] statement underlined that the Bank won’t be reacting to the slight overshoot in inflation. As the Bank contends with trade uncertainties, competitiveness issues, and a shaky housing market, we’re sticking to our forecast that Governor Stephen Poloz moves once more in July before taking an extended break.”

The Bank’s next monetary policy announcement is scheduled for 11 July.

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