Bank of Canada raises interest rate to one percent

Marsha Scott
September 7, 2017

Market watchers who predicted Bank of Canada Governor Stephen Poloz would keep interest rates unchanged this week argued he had the luxury to wait until October, noting inflation remained tepid.

The decision "implies that absent a significant shock, Wednesday's rate increase will be part of a larger and longer march towards interest-rate normalization", said Brian DePratto, TD Bank economist. Markets, shrugging off some of the more dovish language, sent the Canadian dollar to the highest level in more than two years as it interpreted the statement as confirmation the central bank is firmly on a rate hike path. Another rate increase is now nearly fully priced in by December.

The Canadian dollar is now up at 82 cents, which is its highest peak since June 2017, when it reached just over 80 cents.

Adding to the market reaction was the fact the bank didn't repeat language from previous statements about the current degree of stimulus being "appropriate", which suggests it will stay on its tightening path.

"Recent economic data have been stronger than expected, supporting the bank's view that growth in Canada is becoming more broadly-based and self-sustaining", it said. He changed his forecast last week to correctly predict therate increase. Consumer spending remains robust, underpinned by continued solid employment and income growth.

Meanwhile, Statistics Canada reports that Canada's trade deficit in July shrank to $3.04 billion, thanks to a strong Canadian dollar that cut the value of imports (-2.3%) and depressed exports (-1.1%).

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The bank cited Canada's stronger-than-expected economic performance for the hike, warranting a removal of some of the "considerable" stimulus in place.

Yet, there was an introduction of cautionary language in the statement, 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 whether the economy has totally eliminated its slack. Mr. Jean was among those market watchers expecting the Bank of Canada to hold tight this week. It said the Canadian dollar has appreciated - roughly 10% in past three months - and that reflected both domestic strength and weakness in the US currency amid "significant geopolitical risks and uncertainties around" the renegotiation of the North American Free-Trade Agreement, and USA fiscal policy.

Furthermore, the central bank said it would pay "close attention" to how the economy responds to higher borrowing costs, given households have accumulated record levels of debt.

"A rising Canadian dollar without a really good lift from energy prices is tough on the energy sector, and it's tough on any commodity producers", said John Johnston, chief strategy officer at Davis-Rea.

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