Bank of Canada surprises with interest rate hike

BoC Interest Rate 20170712

EDITORIAL: Debt levels a concern

There appears to be a good deal of investors who are hopeful that this upcoming meeting will provide some further confirmation that the hawkish bias is real and the central bank is intending to tighten policy beyond more than just removing the insurance cuts put in place at the height of the oil crash.

But particular focus, it said, will be given to labor market conditions, and given Canadians' high level of indebtedness, "to the sensitivity of the economy to higher interest rates".

The Canadian dollar briefly broke through the 82-cent mark relative to the USA dollar after the Bank of Canada's announcement. The team led by Stephen Poloz and his colleagues chose to raise interest rates in a decision that was not 100% priced in.

A second interest rate hike was already expected in 2018 but if Canada's economy continues to sizzle, it would not be surprising if the central bank aggressively acted by raising rates again earlier to try to keep a lid firmly on inflation.

"What they are saying to me is they are leaving the door open to future hikes", said Derek Holt, head of capital markets economics at Bank of Nova Scotia in Toronto. He changed his forecast last week to correctly predict therate increase.

Masrani declined to quantify the anticipated boost to the bank's revenues from the latest interest rate increase. Futures trading was assigning about a 40 per cent chance of an increase.

"That can't be what the [Bank] wants to see, especially given the recent widening of the trade and current account deficits", BMO economist Benjamin Reitzes had written in a note to clients this morning, prior to the rate announcement. "While an argument could be made that holding off a few weeks for the opportunity to more fulsomely explain how the outlook for the economy has evolved, this clearly did not hold sway in Ottawa today".

That followed unexpectedly healthy growth in the first three months of 2017 and exceeded the Bank of Canada's projections.

In fact, the Bank of Canada cited stronger than expected economic data, including "robust" consumer spending, strength in business investment, exports and solid employment and income growth.

Yet, there was an introduction of cautionary language, and new worries about financial market developments, that weren't in the last rate decision and suggests the central bank isn't quite ready to declare victory on the economy totally eliminating its slack.

In a nod to Lael Brainard, the Bank did say that "wage and price pressures are still more subdued than historical relationships would suggest, as observed in some other advanced economies."So like most industrial countries, Canada too has a fairly flat Phillips curve".

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