The Bank of Canada was seen hiking interest rates at its monetary policy meeting on Wednesday in what was a close call. However, economists were expecting the BoC to hike rates. The BoC signaled that there was room for more rate hikes and the hawkish forward guidance comes amid mounting trade tensions with the United States.
The Bank of Canada was seen hiking interest rates by 25 basis points at last week’s meeting. This was the fourth rate hike from the BoC since it started on a tightening cycle since July last year. The Canadian dollar surged amid BoC’s sanguine view on the trade-related uncertainty.
The BoC’s meeting was dubbed more hawkish than expected. The overall outcome of the meeting was that the central bank is likely to continue with another rate hike for the remainder of the year.
The BoC’s rate hike pushed Canada’s interest rates from 1.25% to 1.50%. The BoC, in its monetary policy statement, said that rising trade tensions with the United States would have a significant impact on the investment and the export sector. However, the BoC raised its second-quarter economic growth forecasts and also signaled that inflation would rise in the near term.
“The size and timing of the effects (of the U.S. tariffs) will depend on multiple factors, including the capacity of Canadian exporters to absorb the tariff costs or to pass them on to their U.S. customers,” the BoC’s statement showed.
The BoC cautioned that retaliatory measures taken by Canada in response to U.S. trade tariffs could cause uncertainty in the industries and especially among workers. However, the BoC was confident that the trade tariff impact would only be modest.
The current U.S. tariffs on steel and aluminum exports from Canada are expected to hit about 2.5% of the Canadian exports. This is expected to drag the GDP lower by 0.6 percentage points, the bank said in its assessment.
On its forward guidance, the central bank changed its language. The BoC said that it would hike rates at a gradual pace and that rate hikes would be data dependent. Central bank officials are seen to monitor the wage pressures as well as firms’ reaction to the trade actions between the United States and Canada.
The central bank also highlighted the positive growth momentum in Canada. The central bank revised its second-quarter GDP estimates from 2.5% given in the April forecast to 2.8%. However, the BoC cautioned that growth could slow in the third quarter to 1.5%.
On inflation, the BoC said that consumer prices would tick higher to 2.5% in the near term before settling close to the BoC’s inflation target rate of 2.0% by the second half of next year.
On wage growth, the BoC said that wages would rise on average about 2.3% and said that this would be a slower pace of growth but that there would be no slack in the labor markets.
The BoC said that temporary factors were a cause for concern for volatility in the short term. The BoC was optimistic that the Canadian economy would expand by about 2.0% on average in the next two years.
While the BoC noted that growth would be driven by exports, it remains to be seen how the trade actions between the U.S. and Canada would play out.