Bank of Canada Raises Policy Rate for First Time Since 2010 -- Update

By Paul Vieira Features Dow Jones Newswires

The Bank of Canada raised its policy rate Wednesday to 0.75% from 0.50%, its first increase in seven years, on an improving economy that is soaking up unused labor and production capacity at a "significant" pace.

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The central bank now anticipates slightly stronger economic growth this year and next, at 2.8% and 2% respectively, than previously forecast, and that "warrants withdrawal of some of the monetary-policy stimulus in the economy." The central bank said any further increases would be guided by incoming economic data, adding that developments on U.S. trade policy -- with the renegotiation of the North American Free-Trade Agreement to begin next month -- and housing also would be taken into account.

With this decision, the Bank of Canada is now the second Group of Seven bank, after the Federal Reserve, to raise rates on stronger economic activity. Signals from the Bank of England and European Central Bank indicate they too are considering the withdrawal of the extraordinary stimulus put in place to help their economies recover and adjust following the 2008-09 financial crisis.

The rate increase was widely expected, as nearly all of the economists at primary dealers of Canadian debt securities surveyed by The Wall Street Journal expected Bank of Canada Gov. Stephen Poloz to remove stimulus.

In its rate decision, the Canadian central bank acknowledged inflation is running below its 2% target, but said this was largely due to temporary factors related to the cost of energy and automobiles. Its forecast has inflation returning close to 2% by mid-2018.

Guiding the Bank of Canada's decision is a "robust" pickup in economic activity, fueled by household spending. Signs abound, it added, that the sources of growth are set to broaden, with exports and business investment playing a larger role. After the economy grew at a G-7 best 3.7% annualized rate in the first quarter, the Bank of Canada anticipates 3% expansion in the April-to-June period, according to its quarterly economic outlook also released Wednesday.

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Jimmy Jean, an economist at Desjardins Capital Markets in Montreal, said the Bank of Canada's statement suggests it is keen to undo the two rate cuts it delivered in 2015. Mr. Poloz said in recent interviews the rate cuts had done their work in positioning the economy for recovery.

"It's clear to me the bank is not in the business of one and done," Mr. Jean said. He added that by down-playing tepid inflation, Bank of Canada officials said they "won't let themselves be paralyzed by minutiae and temporary factors" affecting price increases.

It said the U.S. economy is now growing at a solid pace after a tepid first quarter, and above-potential growth appears to be more widespread in the eurozone.

"Recent data have bolstered the bank's confidence in its outlook for above-potential growth and the absorption of excess capacity in the economy," the central bank said in a statement. "Growth is broadening across industries and regions, and therefore becoming more sustainable."

The Bank of Canada said the output gap, or a gauge of unused capacity in the economy, is set to close at the end of this year, versus its earlier forecast that this would occur in the first half of 2018.

The Bank of Canada last raised its policy rate seven years ago, when current Bank of England Gov. Mark Carney was in charge. Canada's economy recovered relatively quickly following the 2008-09 crisis and avoided the bruising hits dealt to economies in the U.S., the U.K. and elsewhere in Europe. Canada's policy rate got as low as 0.25% in 2009, and in 2010 Mr. Carney raised rates three times to 1%.

The Bank of Canada policy rate remained at 1% until 2015, when it cut rates twice to stave off the fallout from the dropping oil-price shock. At the time, Mr. Poloz said the rate cuts were akin to taking out "insurance" on the economy. The fallout from the commodity-price swoon led to two consecutive quarters of negative output in Canada, and a severe hit to national income.

Wednesday's decision was delivered roughly one month after the Bank of Canada commenced an aggressive, bullish shift in communications about the economy, leading traders and economists to quickly alter rate expectations.

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

(END) Dow Jones Newswires

July 12, 2017 10:46 ET (14:46 GMT)