Bank of Canada Raises Benchmark Rate to 0.75%: Key Takeaways

(Bloomberg)

 The Bank of Canada raised interest rates for the first time since 2010, citing a recent acceleration of growth that it predicts will eliminate fully the economy’s economic slack by the end of this year.

The central bank’s benchmark rate was raised to 0.75 percent, from 0.5 percent, at a rate decision Wednesday. It said future rate moves will be “guided” by the data, while downplaying recent sluggishness in inflation.

With the hike, Canada becomes 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.

Key Points• The Bank of Canada said recent data has increased its “confidence” the economy will continue to grow above potential, meaning excess capacity is being absorbed. 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

• The central bank downplayed recent weakness in inflation, judging the sluggishness as “mostly temporary.” It 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. It gave a nod to the sluggishness by saying the overnight rate will be guided by its inflation outlook

• There was no reference to the 2015 rate cuts. 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.” The statement did say the adjustment to lower oil prices is largely complete

Big Picture

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.

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.

Other Details• 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

• Slowdown in inflation can be “explained mainly by easing consumer energy and automobile price inflation”

• Housing activity expected to ease