Condo Investment Insights

The Bank of Canada is raising its benchmark interest rate again in spite of the intensifying tariff war between the U.S. and its main trading partners.

by Barrie Mckenna

The central bank increased its key rate to 1.5 per cent from 1.25 per cent on Wednesday – the fourth rate hike since last June. The rate, which sets the trend for rates on mortgages and other loans, has not been this high since December 2008.

The move was widely expected by analysts and investors. But there is considerably more uncertainty surrounding the pace of future increases promised by the bank.

“Higher interest rates will be warranted to keep inflation near target and [the bank] will continue to take a gradual approach, guided by incoming data,” the bank said in a statement accompanying the rate decision.

Many economists expect three or four more rate increases by the end of 2019, keeping the Bank of Canada in step with the pace of rate hikes by the U.S. Federal Reserve. At 1.5 per cent, the benchmark rate is still well below the estimated “neutral” level of 2.5 to 3.5 per cent – the point where rates neither heat up the economy nor put the brakes on growth.

“There are worries ahead [and] growth hasn’t been stellar, but the backdrop has been just good enough for the Bank of Canada to nudge rates a quarter point higher,” CIBC chief economist Avery Shenfeld​ said in a research note.

The Canadian dollar initially bounced on the rate hike, rising roughly half a cent from morning lows. However, by late morning, most of the gains were lost with the dollar turning lower to trade at 76.11 US cents just before 11:30 a.m. (ET).

The Bank of Canada acknowledged Wednesday that the hit to the Canadian economy from mounting trade turmoil is likely to be larger than it anticipated in earlier forecasts.

“The possibility of more trade protectionism is the most important threat to global prospects,” the bank said in the statement.

U.S. President Donald Trump said this week that he intends to go ahead with tariffs on another US$200-billion of Chinese goods. China warned it will respond in kind, ratcheting up a potentially destructive showdown between the world’s two largest economies. Mr. Trump is also threatening tariffs on imports of cars and parts from Canada and other countries.

Nonetheless, the Bank Canada insisted the overall impact of trade tensions is still manageable, given the overall strength of the economy. “Although there will be difficult adjustments for some industries and their workers, the effect of these measures on Canadian growth and inflation is expected to be modest,” the bank said.

The combination of tariffs already imposed and ongoing trade uncertainty will knock 0.6 per cent off the level of gross domestic product by the end of 2020, according to the bank’s quarterly Monetary Policy Report, also released Wednesday.

The bank pointed out that the higher price of oil – now just shy of US$74 a barrel – and stronger U.S. growth are offsetting the harm caused by trade problems.

But the estimate of the trade fallout does not take into account the U.S. threat to impose additional duties on imported vehicles and parts – a move the bank warns would cause “large negative spillovers” on consumer spending and business investment across the Canadian economy.

So far, the U.S. has imposed tariffs on newsprint, softwood lumber, steel and aluminum – representing 4.1 per cent of Canadian exports. Ottawa has responded with retaliatory tariffs on U.S. imports.

Overall, the bank expects Canada’s economy to grow 2 per cent in 2018, 2.2 per cent next year and 1.9 per cent in 2020. That’s virtually unchanged from its previous forecast, issued in April.

Elsewhere, the Canadian economy is evolving pretty much as Bank of Canada governor Stephen Poloz and his central bank colleagues had anticipated. Higher interest rates and tighter mortgage lending rules are cooling off the housing market and consumer spending.

That is being offset by higher exports and business investment.

Inflation is now running near 2 per cent, “consistent with an economy operating close to capacity,” according to the bank.

An ongoing puzzle for the bank is the relatively slow pace of wage growth – now rising at an annual pace of 2.3 per cent. That is significantly slower than it should be for an economy at near full capacity.​

Original Post: www.theglobeandmail.com/business/economy/article-bank-of-canada-hikes-rates-uncertainty-hovers-over-future-moves/