David Watt, Economist at HSBC, explains that on expected lines the Bank raised its policy rate by 25 basis points to 0.75% and the rate hike was in the context of an economy that Bank of Canada Governor Poloz said was “approaching full capacity.”
“The hawkish tone of statement seems consistent with our view that the Bank will raise the policy rate to 1.0% on 25 October. That said, relative to the optimistic view of the Bank, we have a more cautious view on inflation, exports and business investment. We expect forthcoming economic data to justify the Bank leaving its policy rate at 1.0% through 2018.”
- The Bank of Canada’s statement reinforces our expectation that the Bank will raise its policy rate by a further 25 basis point increase to 1.0% on 25 October. This would result in the Bank having reversed the emergency 50 basis points of rate cuts from 2015 in response to the decline in oil prices.
- The tone of statement was hawkish and seems consistent with a central bank in the early stages of a more extensive tightening cycle.
- The Bank said that yesterday’s rate hike would withdraw “some of the monetary stimulus,” and the Monetary Policy Report indicated that neutral nominal policy rate was between 2.5% and 3.5%. Hence, even though the current policy rate is now 0.75%, the Bank appears to view the current stance of policy remains quite stimulative.
- That said, we continue to expect the Bank of Canada to leave its policy rate at 1.0% in 2018.
- There are several factors justifying a cautious approach to raising rates above 1.0%. Core inflation has been in decline, and inflation expectations are still in the lower half of the Bank’s target range. Wage growth still remains weak. Exports continue to underperform projections of foreign demand growth, and business investment remains sluggish. Relative to the optimism in the Bank’s Monetary Policy Report, we see a longer period of below target inflation, and a weaker profile for exports and business investment.”