Nafta Update Will Test Poloz’s Caution on Canadian Rate Hikes

(Bloomberg) -- The Bank of Canada is poised to raise borrowing costs more than initially expected now that the prospect of a trade war with the U.S. has eased after the two countries updated Nafta.

Governor Stephen Poloz is now all but certain to boost his key lending rate by a quarter point to 1.75 percent at the next meeting on Oct. 24. Beyond that, it also brings into play the idea the economy can handle more than the two rate increases that had been expected next year, according to economists at some of the country’s largest banks.

“We’re going to have three rate hikes in 2019 and that’s starting to look less cautious,” according to Bank of Montreal economist Robert Kavcic.

Poloz has backed gradual rate increases this year because an economy running at about full output was also facing a drag on investment and exports from U.S. President Donald Trump’s threats to kick Canada out of the North American Free Trade agreement and levy tariffs on automobile shipments. The agreement to get Canada back in, unveiled late Sunday, takes most of the trade risks away, because the early signs are that Prime Minister Justin Trudeau signed a deal without making many major new concessions.

“Canada has made concessions, but is coming out quite clean considering the array of potentially negative options or threats that were on the table,” Kavcic said by phone from Toronto.

Krishen Rangasamy, senior economist at National Bank Financial in Montreal, also said the easing tensions will influence Poloz. “The announcement of the trade deal with the U.S. removes the last obstacle to monetary policy normalization by the Bank of Canada,” he wrote in a research note. “The central bank, which had been concerned about exports and investment amidst rising trade barriers, can now more forcefully address mounting inflation pressures.” National Bank expects an increase in October and three more next year.

Derek Holt, head of capital markets economics at Bank of Nova Scotia in Toronto, said Sunday night’s agreement keeps his forecast on track for a rate increase coming about every quarter. Scotia’s forecast for economic growth next year, currently at 2.1 percent, could get be raised by 0.1 or 0.2 percentage points, he said by phone.

“It’s more about avoiding damage to the Canadian economy than it is any incremental impact from the changes they have secured here,” Holt said.

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