Bank of Canada Surprises With Another Rate Rise -- 2nd Update

By Paul Vieira Features Dow Jones Newswires

The Bank of Canada on Wednesday raised its benchmark interest rate by a quarter-percentage point to 1%, signaling further increases are in the works as Canada's economic growth roars to the top among Group of Seven countries.

Continue Reading Below

This marks the second straight meeting at which Canada's central bank increased its main interest rate, which has been on hold for seven years, and unwinds the two rate cuts it delivered in 2015 to deal with negative fallout from the commodity-price swoon.

Recent indicators, such as a report showing economic growth surged by a strong 4.5% annualized rate in second quarter, support "the bank's view that growth in Canada is becoming more broadly based and self-sustaining, " the Bank of Canada said in a statement explaining its decision. "Given the stronger-than-expected economic performance, [the bank] judges that the removal of some of the considerable monetary policy stimulus is warranted."

The decision came as a surprise. A majority of private-sector economists surveyed by The Wall Street Journal expected the central bank to leave its policy rate unchanged and to wait until its October meeting to raise rates again. The Canadian dollar initially surged on the news to a fresh two-year high, although it pared back some of the early gains.

The decision "implies that absent a significant shock, Wednesday's rate increase will be part of a larger and longer march towards interest-rate normalization," said Brian DePratto, TD Bank economist. He said the overall positive tone of the rate-decision statement suggests rate increases are in store over the next six quarters, to possibly 1.75%, by the end of 2018.

The last time the Bank of Canada's main interest rate sat above 1% was in early 2009.

Continue Reading Below

Other economists said another rate increase could be delivered in late October, when the Bank of Canada's governing council next meets.

"We can't rule out anything in coming meetings," said Doug Porter, chief economist at BMO Capital Markets.

Meanwhile, signals from senior Federal Reserve officials have clouded the outlook for rates in the U.S. with concerns inflation hasn't picked up steam as previously expected.

The Bank of Canada statement said future rate decisions were "not predetermined," and would be guided by incoming economic data and financial-market developments. Inflation remains below the Bank of Canada's 2% target, but the bank said it has evolved as expected in July, with slight rises in headline and underlying inflation reflecting shrinking spare capacity.

Furthermore, the central bank said it would pay "close attention" to how the economy responds to higher borrowing costs, given households have accumulated record levels of debt.

Canada's central bank in July raised its benchmark interest rate by a quarter-percentage point to 0.75%, the first increase since 2010, on the view the economy was approaching full capacity as growth was broadening. As of June 30, or the end of the second quarter, Canada's economy expanded 3.7% on a one-year basis, the best among G-7 economies. Analysts say the stellar results reflect the fact that a major challenge -- the oil-price shock adjustment -- has faded, allowing growth in other sectors and regions of the country to shine through.

Market watchers who predicted Bank of Canada Governor Stephen Poloz would keep interest rates unchanged this week argued he had the luxury to wait until October, noting inflation remained tepid. They added the central bank might also want to gauge market reaction to Federal Reserve plans to shrink its balance sheet and contain any further upward move in the value of the Canadian dollar, which threatened to weigh on export growth.

Statistics Canada reported weak trade results just before the release of the Bank of Canada's decision. For the second-straight month, Canadian exports fell steeply -- 4.9% in July. Yet, Canada's merchandise trade deficit with the rest of the world narrowed in July from the previous month because imports also declined deeply.

In its statement, the Bank of Canada said there had been "widespread strength" in exports and business investment. It said the Canadian dollar has appreciated -- roughly 10% in past three months -- and that reflected both domestic strength and weakness in the U.S. currency amid "significant geopolitical risks and uncertainties around" the renegotiation of the North American Free-Trade Agreement, and U.S. fiscal policy.

The explanation regarding the Canadian dollar's rise suggests the central bank "isn't quite as obsessed" with the currency's value versus the U.S. dollar as traders had long believed, according to Bipan Rai, currency strategist with Canadian Imperial Bank of Commerce. Compared with a basket of other currencies, the Canadian dollar has climbed just 1.1%, Mr. Rai said.

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

(END) Dow Jones Newswires

September 06, 2017 13:35 ET (17:35 GMT)