Bank of Canada increases overnight rate target to 1 1/4 per cent

Bank of Canada increases overnight rate target to 1 1/4 per cent

The global economy continues to strengthen, with growth expected to average 3 1/2 per cent over the projection horizon.

For the third time since last summer, the Bank of Canada has bumped up its key interest rate. "Governing Council will remain cautious in considering future policy adjustments".

"Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity", according to the bank's press release.

The rate increase "was a rear view mirror move, but the Bank of Canada hints that the view out the front window isn't quite as sunny", said Avery Shenfeld, chief economist at CIBC World Markets. The statement explaining the Bank of Canada's rationale and its economic outlook, however, contained its most explicit assessment to date about the negative fallout from Nafta's uncertain future.

A recent IPSOS poll has shown Canadian households are perhaps more indebted now than ever, with an alarming minority of Canadians now living paycheque to paycheque.

The central bank painted a picture of an economy with inflation already close to target, output largely at capacity, a stronger- than-expected housing sector, and a faster-than-expected reduction in labor market slack.

Economists have projected up to three rate increases this year.

The recent Canadian developments have reinforced dual perspectives on CAD prospects through 2018 - that the resumption of gradual BoC normalization would drive outperformance vs lagging peers, but that NAFTA remains a lingering risk, at least in early 2018. "However, uncertainty surrounding the future of Nafta is clouding the economic outlook", the BOC statement read.

"The ongoing strength in the Canadian economy no longer justifies emergency level interest rates". The Bank expects CPI inflation to fluctuate in the months ahead as various temporary factors (including gasoline and electricity prices) unwind.

Uncertainty around U.S. trade policy and recent tax reforms south of the border are expected to knock about 2.5 per cent off business investment in Canada over the next two years, the Bank of Canada said on Wednesday.

Prior to the rate announcement, the markets had priced in a 90-per-cent chance of a rate hike.

And make no mistake: If the central bank hikes its lending rate, the big banks will follow suit.

Still, eight of 31 analysts polled said they expect the Bank to hold rates steady on Wednesday as it waits for inflation to pick up and to see how the next round of NAFTA negotiations later this month proceed.

The central bank estimates the economy grew 3% past year, and is expected to expand 2.2% in 2018.

Since the bank's October projections, financial markets have been in "risk-on" mode with equities rallying and bonds selling off. Oil (West Texas Intermediate) is up 22 percent and holding above US$60 a barrel, while the loonie is up 3 percent and holding around US$0.80. The central bank said it is monitoring the extent to which strong demand could boost potential growth further.

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