The Bank of Canada opted to raise the target for its overnight interest rate this morning 25 basis points to 1.25 per cent. In the statement accompanying the decision, the Bank cited recent strong economic data and rising inflation as motivations for the rate increase. The Bank expects growth in the Canadian economy to slow to 2.2 per cent in 2018 and 1.6 per cent in 2019 with consumption and new home construction contributing less to growth than in years past. With the economy returning to full-capacity, inflation is forecast to remain at 2 per cent over the medium term. The Bank also flagged risk to its outlook from ongoing NAFTA negotiations and noted it would remain cautious in considering future interest rate adjustments.
With the Canadian unemployment rate hitting a 40-year low and inflation ticking higher in recent months, the Canadian economy would seem to be operating at full capacity. That argues for a more hawkish approach to monetary policy in order to bring interest rates closer to what the Bank estimates would be neutral for the economy, that is, a level in which the economy is neither running too hot nor too cold. While today’s rate increase was widely anticipated, it did come earlier in the year than previously expected and likely signals further rate increases to come in 2018. Canadian mortgage rates have already moved higher in anticipation of Bank of Canada tightening, which means a much tighter borrowing environment in 2018, particularly given newly implemented mortgage qualifying rules for low-ratio buyers.
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