BOC Governor Signals July Rate Rise in Play -- 2nd Update

By Paul Vieira Features Dow Jones Newswires

Bank of Canada Gov. Stephen Poloz reignited expectations for a rate increase next month by saying excess slack in the Canadian economy is now being absorbed "steadily" at the current pace of growth.

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His comments in Portugal, during an interview with CNBC Europe that aired Wednesday, drove the Canadian dollar to a four-month high and pushed up yields on government of Canada bonds. The remarks came as central bankers in Europe and the U.K. also signal their intent to remove stimulus from their economies.

Mr. Poloz said growth in Canada would decelerate following a strong 3.7% annualized gain in the first quarter, top among the Group of Seven leading nations. But he said he doesn't envisage a dramatic slowdown.

Growth would register at a "more normal pace but still above potential," he said. "That's the important thing. That means that we're absorbing excess capacity that was built up in the wake of the crisis and then built up again in the wake of the oil shock two years ago."

When pressed on how that would affect the central bank's policy-rate decision next month, Mr. Poloz said officials "need to be at least considering that whole situation now that the excess capacity is being used up steadily."

BMO Capital Markets altered its rate outlook following Mr. Poloz's comments, and said it expects the central bank to raise its policy rate, currently at 0.50%, in July. The firm previously forecast a rate increase in January 2018. It said messaging in recent weeks indicates the central bank wants to begin unwinding the rate cuts it delivered in 2015 to help the economy deal with a sudden drop in commodity prices.

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Jimmy Jean, economist at Desjardins Capital Markets, said in an interview he has a "strong bias" toward a July rate increase, saying Mr. Poloz didn't mention in his interview any concerns related to soft inflationary pressure.

"To me it is increasingly hard to square off these comments at this juncture, with a scenario of a central bank that is just happy to introduce hawkish language in the next statement and wait further before hiking," Mr. Jean said.

On the overnight-index swap market, traders Wednesday priced in a roughly 70% probability of a rate increase July 12, up from a roughly 40% probability the previous day.

Investors warmed up to the Canadian dollar, pushing the currency to a four-month high after Mr. Poloz's comments. The loonie was trading at about 76.59 U.S. cents early Wednesday, from 75.74 U.S. cents late Tuesday.

Meanwhile, Canadian bond yields rose sharply, with the front end outperforming the rest of the curve, according to CanDeal. The yield for Canada's two-year bonds was at 1.017% from 0.964% on Tuesday, while the 10-year bond was yielding at 1.599% from 1.565%. Bond yields move inversely to price.

Similar market movement unfolded in the U.K., as the pound jumped to a three-week high after Bank of England Gov. Mark Carney said interest rates in the U.K. may need to rise if the economy keeps growing despite weak consumer spending.

Mr. Poloz and the Bank of Canada's No. 2 official, Carolyn Wilkins, rattled markets in June with a sea change in commentary that signaled the bank was laying the groundwork to raise its benchmark rate.

They both said rate cuts they delivered in 2015 to offset the negative shock from the commodity-price swoon have worked, with the economy now growing at a firmer pace and broadening on a sectoral and regional basis. Ms. Wilkins said it is time to assess whether rock-bottom rates are still necessary.

Previously, the central bank had urged caution on the Canadian outlook amid a string of strong economic data, citing uncertainty in U.S. trade policy as an important concern, and the presence of spare labor and production capacity.

David George-Cosh contributed to this article.

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

June 28, 2017 13:04 ET (17:04 GMT)