Bank of Canada joins in the Fed in hiking interest rates

Summary:

  • Bank of Canada hikes interest rates by 25 bps as expected
  • BoC becomes the second central bank among G7 nations to join the rate hike club
  • Rate hike is the first in nearly seven years
  • BoC held interest rates steady at 0.50% for nearly 13-months
  • Markets expecting another rate hike before the end of the year

The Bank of Canada became the second G7 economy to join the rate hike club, following in the footsteps from the U.S. Federal Reserve.

As widely expected, the Canadian central bank hiked interest rates by 25 basis points to bring the short term interest rates to 0.75%. This was the first rate hike in nearly seven years.

“Governing Council judges that the current outlook warrants today’s withdrawal of some of the monetary policy stimulus in the economy. Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities,” the bank said in its statement.

Interest rates in Canada were held steady for nearly 13-months after the BoC lowered the base rate to 0.50% in July 2015. Back then the central bank had called it an “insurance” to adjust the economy against falling oil prices.

After nearly 13-months of stable interest rates, the rate hike was well communicated with BoC’s Poloz signaling to the markets just under a week ago that inflation could turn to the uptrend.

Despite the rate hike, the BoC governor Poloz said that monetary policy was not on a predetermined path but sounded positive that he did not doubt that interest rates will be higher over time.

“It will remain highly data-dependent as we move forward,” Poloz said speaking about the future pace of rate hikes.

Growth in Canada has picked up momentum putting it in one of the strongest periods of growth since the 2008 recession. For the past four quarters, growth in Canada has been steady at over 3% which puts it as one of the fastest growing economies among the group of seven nations.

Adding further to the momentum in the Canadian dollar, experts are noting that besides monetary policy playing a key role for the markets, the Loonie could also benefit from oil prices and the yield spreads between the U.S. and Canada.

On the flipside, a higher exchange rate could possibly impact the export sector in Canada, which has benefited so far on a weaker exchange rate over past few years. However, any further appreciation in the exchange rate could compel the manufacturing sector to increase their imports in order to offset any revenues lost on account of weaker sales.

Market reaction to the BoC rate hike

The Canadian bond market reacted to the rate hike with the front end of the curve rising. The two-year bond yields in Canada rose from 1.124% to 1.196% following the BoC’s decision on Tuesday. Yields on the 10-year bonds rose to 1.881% from 1.860% as well.

The hawkish but guarded tone from the BoC helped to sustain the Canadian bond market despite the fact that the rate hike was widely expected.

Following the BoC’s decision, the bond markets are now signaling the possibility of the next rate hike to be in October followed by April next year.

The Canadian dollar rose to a 12-month high against the U.S. dollar. The fact that the BoC had managed to stay optimistic on inflation and brushed aside concerns helped the Loonie to post gains. The decline in USDCAD is expected to see the currency pair eventually slide towards the next major technical support at 1.2536.