Bank of Canada Raises Overnight Interest Rates
The Bank of Canada raised its overnight benchmark rate by a quarter point to 1.75% on October 24, 2018; the third hike this year and fifth since it began increasing rates in 2017. More importantly, its statement no longer references taking a “gradual approach”, instead adding language about the need to bring rates to levels that are no longer expansionary.
“Governing Council agrees that the policy interest rate will need to rise to a neutral stance to achieve the inflation target,” policy makers led by Governor Stephen Poloz said, adding the pace will depend on how Canada’s economy adjusts to higher rates and how global trade policy unfolds.
The statement suggests policy makers are growing increasingly determined to return Canada’s historically low borrowing costs to more normal levels, since a run of strong data suggests the economy is running up against capacity and is healthy enough to cope with rate normalization. The Canadian dollar jumped after the statement.
Future Rate Path
Officials seem to be indicating they expect the current hiking cycle will include at least three more rate increases after Wednesday’s move, given the central bank estimates the neutral rate at anywhere between 2.5% and 3.5%. The neutral rate is a level that is neither stimulative nor contractionary.
Swaps trading suggests financial markets are anticipating interest rates will rise to the bottom end of the range by the end of next year, where policy makers are expected to stop the cycle.
The tone suggests the Bank of Canada may go even higher than that, and move at a faster pace than the market currently expects. One thing the removal of the gradual wording does is give policy makers room to raise interest in back-to-back decisions.
Despite dropping its reference to moving gradually, the central bank did retain language in its statement that linked the future pace of rate increases to the economy’s adjustment to higher borrowing costs in the face of elevated household debt levels. Before the statement, the market was anticipating another increase by January, followed by a move in the second quarter of next year and another in the second half of 2019.
“In determining the appropriate pace of rate increases, Governing Council will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt,” the Bank of Canada said. “In addition, we will pay close attention to global trade policy developments and their implications for the inflation outlook.”
Source | Bloomberg
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