Bank of Canada Surprises With Another Rate Rise -- 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%, saying stronger-than-anticipated growth -- highlighted by a blockbuster performance in the second quarter -- warrants the removal of "considerable" stimulus from the economy.

Continue Reading Below

This marks the second straight meeting Canada's central bank increased its main interest rate, after being on hold for seven years. The decision comes 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, while signaling gradual rises were in the offing in the coming months.

Trading in the overnight-index swap market suggested a 40% probability of another rate rise from the Bank of Canada in September, after a quarter-percentage point rise in July.

Recent indicators, such as a report showing the country's gross domestic product rose by a strong 4.5% annualized rate in the April-to-June period, 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."

In response, the Canadian dollar suddenly moved to a new two-year high against the U.S. dollar, trading at 82.38 U.S. cents moments after the release of the statement from 80.58 U.S. cents right before the announcement.

"The message being sent they are ready to hike rates, irregardless of developments in the U.S.," said Jimmy Jean, economist at Desjardins Capital Markets. Mr. Jean was among those market watchers expecting the Bank of Canada to hold tight this week. He said the central bank's justification "makes sense, but we are surprised nonetheless."

Continue Reading Below

The bank statement said future rate decisions were "not predetermined," and would be guided by incoming economic data and financial-market developments, and their impact on the inflation outlook. Inflation remains below the Bank of Canada's 2% target, but it 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, or best among Group of Seven economies. Analysts say the stellar results reflect the fact that a major headwind -- the oil-price shock adjustment -- has faded, leaving above-potential 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.

As it happens, 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 and that reflected 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.

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

(END) Dow Jones Newswires

September 06, 2017 11:08 ET (15:08 GMT)