Canada became the first Group of Seven country to join the U.S. in raising interest rates on Wednesday, potentially fueling speculation the world’s central bankers are heading into a tightening cycle.
The central bank’s benchmark rate was raised to 0.75 percent, from 0.5 percent. It said future rate moves will be “guided” by the data, while downplaying recent sluggishness in inflation.
Investors are looking at the decision as a possible harbinger of things to come globally and are monitoring it for clues on the central bank’s resolve for withdrawing stimulus, with the prospect of central bank tightening has triggered a selloff in government bond markets over the last two weeks. Canadian government bonds yields and the country’s currency are up after the hike.
“Governing Council judges that the current outlook warrants today’s withdrawal of some of the monetary policy stimulus in the economy. Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the Bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities,” it said in the statement.
Canada is in the midst of one of its strongest growth spurts since the 2008-2009 recession, with the expansion accelerating to an above-3 percent pace over the past four quarters. That’s the fastest among Group of Seven countries and double what the central bank considers Canada’s capacity to grow without fueling inflation.
The Bank of Canada said the acceleration in growth, and its broadening to more sectors and regions, has increased its “confidence” the economy will continue to grow above potential, meaning excess capacity is being absorbed.
There wasn’t much indication on the future path to rates, outside the nod to data. One of the big questions investors had ahead of the rate decision was whether the central bank’s focus was the 50 basis points of cuts implemented in 2015. Just last month, Governor Stephen Poloz said that what the recovery “suggests to us is that the interest rate cuts that we put in place in 2015 have largely done their work.” While the statement did say the adjustment to lower oil prices is largely complete, there was no reference to the 2015 rate cuts.
The statement had “no detailed hints on when the next hike is coming other than boilerplate language that it will depend on the data, but October (the next MPR) is our favored pick, since by skipping September the Bank can signal that this will be a gradual process,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in a note to investors.
The central bank estimates the economy will return to full capacity by the end of 2017. In April, it had predicted the closing of the output gap in the first half of 2018. The bank estimates the degree of excess capacity in the second quarter of this year is between zero and 1 percent of GDP.
“Recent data have bolstered the Bank’s confidence in its outlook for above-potential growth,” it said.
The central bank downplayed recent weakness in inflation, judging the sluggishness as “mostly temporary.” Not only has inflation been sluggish, it’s also been weakening with consumer prices in May up 1.3 percent on an annual basis — the slowest pace this year.
The central bank predicted inflation will return “close to” its target of 2 percent by the middle of 2018 — which is later than it had predicted in April. The slowdown can be “explained mainly by easing consumer energy and automobile price inflation,” it said.
- The central bank cites broadening of Canadian growth across industries and regions as one reason for its confidence in sustainability of expansion
- The Bank of Canada cites broadening growth across countries as well
- The central bank estimates GDP growth of 2.8 percent in 2017, versus an April forecast of 2.6 percent. Growth in 2018 is estimated at 2 percent, and 1.6 percent in 2019
- The better than expected growth in 2017 is largely being driven by household spending, which is contributing 1.9 percentage points to the growth rate. Outside of stronger household spending in 2017, the outlook for everything else over the next three years is little changed from April forecasts
- No mention of Canada housing market in rate statement
- Bank of Canada removes its expectations for a stimulus boost from the U.S. fiscal measures of half a percent point to the level of U.S. GDP by mid-2019
- Slumping core inflation globally requires further analysis, but may include structural changes related to technology and falling inflation expectations
- Labor market indicators suggest slack in the labor market is being absorbed, albeit with a lag, the central bank said in its monetary policy report
- Housing activity expected to ease