Bank of Canada Raises Rates, Says Stimulus No Longer Warranted

(Bloomberg) -- The Bank of Canada pressed ahead with a fresh interest rate increase and acknowledged for the first time in more than a decade it expects to completely remove monetary stimulus from the economy.

The Ottawa-based central bank raised its overnight benchmark rate by a quarter point to 1.75 percent Wednesday, the third hike this year and fifth since it began tightening in 2017. More importantly, it dropped references to taking a “gradual approach” and added language about the need to bring rates to levels that are “neutral,” or no longer expansionary.

Policy makers, buoyed by the country’s new trade deal with the U.S. and Mexico, are increasingly determined to return borrowing costs to more normal levels, as recent data suggests the economy is strong enough to cope with tighter policy. The Canadian dollar jumped after the decision on speculation the pace of hikes would accelerate.

“The reality is the economy is running at its capacity and it is no longer needing stimulus and so it’s our job to prevent the thing from overheating,” Governor Stephen Poloz told reporters at a press conference after the decision.

At the same press conference, Senior Deputy Governor Carolyn Wilkins pointed out that borrowing costs are still relatively low, with the policy rate below the rate of inflation. “What stands out is that, even with today’s increase in the policy rate to 1.75 percent, monetary policy remains stimulative,” she said.

Future Rate Path

Officials may be indicating they expect the current cycle will include at least three more increases after Wednesday’s move, given the central bank estimates the neutral rate -- a level that’s neither stimulative nor contractionary -- is between 2.5 percent and 3.5 percent.

“Governing Council agrees that the policy interest rate will need to rise to a neutral stance to achieve the inflation target,” they said in their statement, adding the pace will depend on how Canada’s economy adjusts to higher rates and how global trade policy unfolds.

Swaps trading suggests interest rates will rise to the bottom end of the neutral range by the end of next year, where policy makers are expected to stop the cycle.

There may be scope for Poloz and his colleagues to go even higher than that, and to get there more quickly than the market currently expects.

“It sounds like they are teeing up another hike in December,” Derek Holt, head of capital markets economists at Bank of Nova Scotia, said in a telephone interview. “I expected a more hawkish overall tone, but didn’t think they would drop ‘gradual’ just yet. They sound much more rushed to get to neutral.”

Loonie Reaction

Markets reacted to the more hawkish tone. The Canadian dollar climbed 0.6 percent to C$1.3005 per U.S. dollar at 1:20 p.m. in Toronto, while two-year government bond yields rose 4 basis points to 2.32 percent.

Removing the gradual wording gives policy makers scope to make back-to-back increases. At the same time, Poloz and Wilkins took pains to point out the change in language could also mean the pace could go slower if the data turn sour.

The central bank did retain language in its statement that linked the future pace of increases to the economy’s adjustment to higher borrowing costs in the face of elevated household debt levels. Before the statement, the market was anticipating another increase by January, followed by a move in the second quarter of next year and another in the second half of 2019.

“In determining the appropriate pace of rate increases, Governing Council will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt,” policy makers said in the statement. “In addition, we will pay close attention to global trade policy developments and their implications for the inflation outlook.”

©2018 Bloomberg L.P.