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The Quick Take: July 11, 2018

Bank of Canada Hikes Rates

Alicia Macdonald
Principal Economist
National Forecast

“As expected, the Bank of Canada increased its target for the overnight rate by 25 basis points to 1.5 per cent this morning. Looking ahead, we expect only moderate economic growth this year and that should keep the Bank on the sidelines until January.”

With inflation hovering around target and the economy operating near capacity, The Bank of Canada lifted its policy rate by 25 basis points today, marking the second increase this year.

In its press release accompanying the decision, the Bank stated that the composition of Canadian economic growth is shifting with business investment and exports picking up and household spending moderating. The Bank also pointed to a need for higher rates in the future to keep inflation at target and that its decisions will be data dependent.

We expect the Bank to take a very gradual approach to withdrawing monetary stimulus given building global trade tensions and slowing economic growth.

Since the Bank’s last policy decision, the U.S. has slapped tariffs on imports of steel and aluminum from Canada. Global trade tensions have also escalated with the U.S. and China imposing tariffs on goods shipped between those countries and just yesterday the U.S. announced it is looking at potential tariffs on another $200 billion in Chinese imports. As noted by the Bank today, the possibility of more protectionist trade measures is the greatest threat to global growth prospects.

Going forward, the pace of interest rate increases will depend on how fast the Canadian economy grows in relation to growth in our capacity (potential output) and our forecast is calling for moderate economic growth.

Even before the recent imposition of tariffs on Canadian steel and aluminum products, the troubles on the trade front were evident with non-energy exports contracting last year for the first time since 2009. We expect that the sector will continue to struggle this year with non-energy exports expected to remain flat.

On top of the poor growth prospects in non-energy exports, consumer spending—the driver of economic growth last year—has slowed sharply and the housing resale market is still adjusting to new provincial and federal measures designed to cool activity.

Overall, our forecast calls for growth that is strong enough to continue to absorb the little excess capacity remaining in our economy but not so strong that the Bank of Canada will need to abandon its plan to lift rates at a gradual pace with the next increase not expected until January.

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