Bank of Canada Hikes Rates By 25bps, Loonie Rises On Hawkish Take

The Bank of Canada raised the overnight rate by 25bps to 1.5%, in line with consensus estimates.

In justifying the move, the Bank said it expects the global economy to grow by about 3.75% in 2018 and 3.5% in 2019, adding that the US economy is proving stronger than expected, reinforcing market expectations of higher policy rates and pushing up the US dollar. It warned that this is “contributing to financial stresses in some emerging market economies” suggesting that Canada was dragged into the rate hikes rather than welcoming it.

In other words, the BOC hopes that demand from the U.S. will trump the drag on trade from tariffs the two neighbors, as well as the uncertainty over the future of Nafta.

It also noted that while oil prices have risen, the Canadian dollar is lower, reflecting broad-based US dollar strength and concerns about trade actions, noting that “the possibility of more trade protectionism is the most important threat to global prospects.”

Perversely, even as the BOC hiked rates, it warned that household spending is “dampened by higher interest rates and tighter mortgage lending guidelines.”

Curiously, despite market concerns, the BOC raised its Q2 GDP forecast to 2.8% from 2.5% previously, with Q3 seen at 1.5%; The bank also raised the potential output growth to 1.8% in 2018, and 1.9% in 2019 and 2020.

Commenting on the ongoing trade war with the US, the BOC estimates US tariffs on steel and aluminium will reduce level of real Canadian exports by 0.6%, with the impact expected to be felt in H2 2018. Meanwhile, Canadian counter measures estimated to reduce real imports by 0.6% starting Q3, while tariffs will temporarily boost inflation in Q3 2019.

The statement also points to potential for more trade risk: “As in April, the projection incorporates an estimate of the impact of trade uncertainty on Canadian investment and exports. This effect is now judged to be larger, given mounting trade tensions.”

The BOC also said that it will take a gradual approach, guided by incoming data.

Some other notable highlights from the report:

  • BOC raises potential output growth to 1.8% in 2018, 1.9% in 2019 and 2020
  • BOC says CPI inflation expected to edge up further to 2.5%, before settling back to 2% in H2 2019
  • CPI and core CPI remain near 2%, consistent with with an economy operating close to capacity
  • Says wage growth running about 2.3%, slower than expected in a labour market with no slack

* * *

So is the report hawkish or dovish? According to some the former prevails due to the following:

  • No new dovish language, with the guidance unchanged from “higher interest rates will be warranted to keep inflation near target and will continue to take a gradual approach, guided by incoming data.”
  • The latest projection incorporates the estimated impact of tariffs on steel and aluminum recently imposed by the United States, as well as the countermeasures enacted by Canada. “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.”
  • A upward revision to Q2 GDP from 2.5% in April to 2.8% in the July update
  • And a stronger read on the economy: “In the first quarter of 2018, business investment and exports were more robust than anticipated. Stronger levels of spending are expected to persist over the projection horizon, partly reflecting higher oil prices, even with the larger impacts from both trade policy uncertainty and tariffs.”

The loonie’s kneejerk reaction has been to rise modestly, higher by 40 pips against the USD to 1.3100, reflecting what appears a victory for the hawkish take, at least initially.


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Author: Tyler Durden

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