Bank of Canada rate hike signals healthy Canadian economy

July 13, 2018 Wesley Blight

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As most expected, the Bank of Canada (BoC) raised interest rates 0.25% to 1.50% on July 11th, 2018. The BoC cited solid global growth which is in line with expectations, Canadian exports that are being supported by strong global demand and higher commodity prices, growth in Canadian business investment, and the stabilization of the domestic housing market.

This is the fourth increase since July 2017 and BoC Governor Stephen Poloz said the latest increase was needed to keep inflation at the bank’s 2.0% target. The decision was broadly aligned with the BoC’s prior announcements and has set the stage for further increases over the next 12 months.

A data driven decision

The BoC raised the rate for a number of reasons:

  1. Economic expansion in Canada continues to operate near capacity and future growth is expected to outpace potential;
  2. The transition of the Canadian economy from being reliant on household spending to greater contribution from exports and business spending is moving along and expected to continue;
  3. Labour conditions remain healthy with the unemployment rate remaining steady near its 40-year lows;
  4. Lastly, better than expected U.S. economic growth, supporting overall global growth.

Things to look out for

With the decision to increase rates this week, the BoC is keeping an eye on a few risks that could lead to more modest rate hike expectations for the future:

  1. Despite robust labour data and strong overall economic growth, wage growth remains stubbornly lower than expectations;
  2. Escalating global trade tension creates uncertainty and could threaten global prospects. It’s important to note that realized trade barriers are directly included in the latest BoC projections and the loss of confidence created by the uncertainty of threatened trade actions are also considered.

Markets were expecting the decision

As mentioned in our earlier response, there were no surprises with the markets. The Canadian dollar appreciated against the U.S. dollar at the time of the announcement but has since come back down. Canadian treasury yields only moderately increased and the S&P/TSX Composite Index has recovered from the July 11th trading day.  

Given the BoC’s 2.0% mid-point inflation target, it’s interesting to note that headline inflation is expected to temporarily exceed the target, however this is likely to subside and did not have an impact on the July 11th decision.

Continuing with our current strategy

For now, we remain aligned with our past comments, as well as the forward-looking perspective from the July 11th announcement. Our fixed income fulfillment remains positioned for modest increases to Canadian interest rates. We continue to favour longer term bonds as short-term bond yields are expected to increase by more than their longer term counterparts, putting pressure on short-term bond prices.


No surprise, the Bank of Canada raises rates to 1.50%

As expected, the Bank of Canada (BoC) raised interest rates to 1.50% from 1.25% this morning. In the official announcement released earlier today, the BoC cited solid global growth which is in line with expectations, Canadian exports that are being supported by strong global demand and higher commodity prices, growth in Canadian business investment and the stabilization of the domestic housing market.

Despite this, the Canadian dollar remains low, highlighting concerns about recent trade actions. The BoC believes that the recent tariffs imposed by the U.S., as well as the countermeasures enacted by Canada, will have a modest effect on Canadian growth and inflation, but states that more trade protectionism is the most important threat to global prospects.

Market reaction following the announcement has been varied. There was a modest bump in the Canadian dollar and Canadian bond yields. However, the S&P/TSX Composite Index dipped further after starting the day lower.

We will follow this blog post with a more in-depth analysis of the BoC decision, the latest Monetary Policy Report and what it means for your portfolio.

 

About the Author

Wesley Blight

Wesley Blight, CFA, CIM, FCSI, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He is responsible for the investment results of the firm’s fixed income and multi-asset products.

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