Canada No Longer Needs Strong Stimulus, Central Bank Says -- 2nd Update

By Paul Vieira Features Dow Jones Newswires

In the surest signal yet that the Canadian economy has turned a corner after the oil-price shock, the Bank of Canada on Wednesday raised its policy rate by a quarter percentage point, to 0.75%, its first increase in seven years.

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Bank of Canada Gov. Stephen Poloz said Wednesday rock-bottom rates are no longer necessary amid the bank's expectations of slightly stronger economic growth this year and next, at 2.8% and 2% respectively, than previously forecast.

The improving economy has soaked up unused labor and production capacity at a "significant" pace, the bank said, and a string of improving indicators measuring employment, exports and business-investment intentions suggest the time has come for a rate rise.

"The most important thing here is the economy clearly no longer needs as much stimulus as we have been giving it," Mr. Poloz said at a press conference in Ottawa. "The accumulation of evidence, and the growth in our confidence that the economy is on a solid trajectory, should be good news for everyone."

Mr. Poloz added a rate rise would also "reinforce efforts" among Canadian authorities to take some steam out of the housing market. Frothy pockets in the Toronto and Vancouver real-estate markets pose a top vulnerability to financial stability, the Bank of Canada and others have warned.

The Bank of Canada is now the second central bank in the Group of Seven leading nations, after the Federal Reserve, to raise rates in response to 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.

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Canada's economy is a top performer among the G-7, leading the pack in first-quarter growth, with a 3.7% annualized gain. The Bank of Canada now forecasts 3% growth in second quarter before activity moderates in the second half.

"And so the tide begins to turn," said Douglas Porter, chief economist at BMO Capital Markets, on the central bank's move. "The initial indications are that the bank fully expects to follow through with another rate hike."

His firm expects the Bank of Canada's policy rate to hit 1.5% by the end of the year.

Traders were also betting on further rate rises, given Mr. Poloz's upbeat tone, with the Canadian dollar hitting a fresh 12-month high. In afternoon trading, the U.S. dollar was around C$1.2713, down from C$1.2910 right before the rate decision, according to data provider CQG.

As the Bank of Canada delivered its first rate increase since 2010, Fed Chairwoman Janet Yellen was testifying on Capitol Hill. She told lawmakers she expects consumer prices will allow the central bank to keep gradually raising interest rates. She added the Fed would alter its plans if weak inflation proved more persistent. Stocks and government bonds rallied on the news.

At his press conference, Mr. Poloz played down concerns over low inflation, which in May was 1.3%, or well below the Bank of Canada's 2% target. The bank said this was largely due to temporary factors, related to the cost of energy and automobiles.

He said the Bank of Canada's job is to target "future" inflation. Its forecast has price increases returning close to 2% by mid-2018, as temporary factors fade and the price of food picks up steam.

Because it can take 18 to 24 months before low rates can influence inflation, "reacting only to the latest inflation data would be akin to driving while looking in the rear view mirror," he said.

Jimmy Jean, an economist at Desjardins Capital Markets in Montreal, said these comments suggest the central bank won't let itself "be paralyzed by minutiae and temporary factors" affecting inflation in the pursuit of tighter monetary policy.

The central bank said the output gap, or a gauge of unused labor and production capacity in the economy, is set to close at the end of this year, versus its earlier forecast of the first half of 2018. Closing the gap tends to put upward pressure on prices and wages.

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%.

David George-Cosh contributed to this article

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

(END) Dow Jones Newswires

July 12, 2017 15:59 ET (19:59 GMT)