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Upbeat BOC Statement Buoys Loonie

Don Curren July 11, 2018

The Bank of Canada raised its overnight target rate by 25 basis points to 1.50% Wednesday, as widely expected, and issued a policy statement that conveyed a remarkably positive outlook on the economy despite severe trade tensions between Canada and its largest trading partner the US.

Currency traders responded to that with some positivity of their own, pushing the Canadian dollar about 0.05% higher against its US counterpart after the statement. Many had expected the Bank to raise rates, but issue a more “dovish” statement than it ultimately did.

In wording extremely similar to that of its last statement in May, the Bank said it “expects that higher interest rates will be warranted to keep inflation near target and will continue to take a gradual approach, guided by incoming data.”

“In particular, the Bank is monitoring the economy’s adjustment to higher interest rates and the evolution of capacity and wage pressures, as well as the response of companies and consumers to trade actions,” the statement said.

The Bank said its new growth projection incorporates the estimated impact of tariffs on steel and aluminum recently imposed by the United States, as well as the countermeasures enacted by Canada.

”Although there will be difficult adjustments for some industries and their workers, the effect of these measures on Canadian growth and inflation is expected to be modest,” the Bank’s statement said.

It cautioned, however, that “(the) possibility of more trade protectionism is the most important threat to global prospects.”

The Bank projects a pick-up to 2.8% in the second quarter and a moderation to 1.5% in the third. It said household spending is being dampened by higher interest rates and tighter mortgage lending guidelines, adding that recent data suggest housing markets are beginning to stabilize following a weak start to 2018.

The Bank said exports are being buoyed by strong global demand and higher commodity prices. “Business investment is growing in response to solid demand growth and capacity pressures, although trade tensions are weighing on investment in some sectors,” it said.

Overall, the Bank still expects average growth of close to 2% over 2018-2020.

Traders in Canadian rate markets were pricing in about a 96% chance the Bank would raise rates at Wednesday’s announcement.

A high probability was priced in shortly after the Bank’s last policy statement, which nodded forcefully in the direction of further hikes.

Traders reduced the odds of a hike after the imposition of US metal tariffs on Canada on May 31, retaliatory tariffs from Canada, and US President Donald Trump’s disruptive performance at the G7 summit in Quebec, and his tweet labeling Canadian Prime Minister Justin Trudeau as “very weak and dishonest.”

But rate markets took the probability of a rate increase back to much higher levels after a speech and news conference in late June in which Bank of Canada Governor Stephen Poloz reaffirmed the Bank’s commitment to monetary tightening.

Today’s move marks the fourth 25-bps increase in the Bank’s policy rate since the beginning of the sporadic rate tightening program it launched almost exactly a year ago.

It’s hard to assess the likelihood of further rate increases, but some economists had hypothesized this will be the last hike in the current cycle before today’s statement.

Bottom Line: The Bank of Canada’s rate hike Wednesday was well expected by markets, but its upbeat view of the economy wasn’t. The positive tone of the statement boosted the Loonie, and may embolden it further in the days to come.

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