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Bank of Canada raises interest rates for first time in seven years

Stephen Poloz, Governor of the Bank of Canada holds a news conference concerning the rise of the bank's interest rates, in Ottawa, Tuesday July 12, 2017.

Fred Chartrand/THE CANADIAN PRESS

The Bank of Canada's first interest-rate hike in seven years has set in motion a complex unwinding of a near-decade-long era of easy money.

The central bank raised its overnight lending rate by a quarter-percentage-point Wednesday, to 0.75 per cent from 0.5 per cent, citing "bolstered" confidence that the Canadian economy has emerged from years of sputtering growth.

Some borrowers are already paying the price. Canada's largest banks matched the central bank's move by raising their prime rates effective Thursday by a quarter-percentage-point to 2.95 per cent. Prime rates influence the cost of borrowing on floating-rate loans, including variable-rate mortgages, credit lines and student loans.

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Bank of Canada Governor Stephen Poloz justified the hike, saying he's increasingly convinced that the Canadian economy has "turned the corner" after a series of false starts, including the oil price plunge in 2014 and 2015.

"Growth is broadening across industries and regions and therefore becoming more sustainable," the bank explained in a statement.

The Bank of Canada's burgeoning optimism sent the Canadian dollar shooting up more than a full cent to nearly 79 cents (U.S.) on Wednesday as investors brace for further rate hikes in the months ahead.

Ultra-low interest rates have encouraged Canadians to load up on mortgage debt in recent years, driving home prices and home construction, particularly in and around Toronto and Vancouver. But they have also penalized savers and made it tough for pension funds to generate healthy returns.

Higher rates will help to cool the housing market and rein in debt-fuelled purchases of cars and other consumer items.

The move to higher rates isn't just a Canadian phenomenon. Central bankers in the United States and Europe are also talking about ending emergency measures put in place to keep credit flowing after the 2008-09 financial crisis. U.S. Federal Reserve Chair Janet Yellen told Congress on Wednesday that the economy is now healthy enough to handle further steady increases in its benchmark interest rate as well as a start to selling its $4-trillion store of commercial bond holdings later this year.

One of the puzzles for the Bank of Canada and other central banks is that inflation is still low and falling. Central bankers typically raise rates to keep inflation in check. That isn't the problem in Canada, where consumer prices have been rising at well below the bank's 2-per-cent inflation target.

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But Mr. Poloz said he's looking beyond current conditions, focusing on where inflation will be a year or two from now. "Reacting only to the latest inflation data would be akin to driving while looking in the rear-view mirror," he explained to reporters in Ottawa after the rate announcement.

Inflation may weaken further in the months ahead before getting back to the 2-per-cent target by the middle of next year as excess capacity in the economy fades, according to the Bank of Canada's Monetary Policy Report, released Wednesday. The bank argues that recent declines in inflation are largely temporary – the result of lower gasoline prices, electricity rebates in Ontario, intense food price competition and unexpectedly weak car prices.

The bank is still being coy about when its next rate hike will come. The bank will "remain highly data-dependent," Mr. Poloz insisted. "Monetary policy is not on a predetermined path."

Many economists are expecting at least one more rate hike this year, most likely in October, when the bank releases its next quarterly forecast.

Bank of Montreal chief economist Douglas Porter said the Bank of Canada's move begins a process that could see the central bank's key rate bumped up to 1.5 per cent by mid-2018. "And so the tide begins to turn," he said.

Unless inflation continues to fall, Canadians should expect more rate hikes, TD economist Brian DePratto said.

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The Bank of Canada said the 3.5-per-cent annual pace of GDP growth in the first quarter will "moderate" over the rest of the year, but remain "above potential." Among other things, the bank expects consumer spending, exports and business investment to drive growth in the months ahead.

The bank pointed out that housing activity has already abated, particularly in the Toronto area, where homes sales have fallen sharply.

The bank now estimates that the so-called output gap – a measure of excess labour, factory capacity and the like – will close "around the end of 2017." That's significantly sooner than its assessment in April that the gap would disappear in the first half of next year.

The Bank of Canada cut rates twice in 2015, taking out what Mr. Poloz called "insurance" against the fallout from the collapse in the price of oil and other commodities. More recently, he has said that those cuts "have largely done their work" as the effects of the oil shock receded in Canada's oil patch.

"Higher interest rates are what is needed to reduce the vulnerability of high household indebtedness and real estate price imbalances in parts of the country," Conference Board of Canada chief economist Craig Alexander said.

The Bank of Canada now expects the economy to grow 2.8 per cent this year, or faster than the 2.6-per-cent pace it predicted in its April forecast. GDP growth will slow to 2 per cent in 2018 and 1.6 per cent in 2019, the bank said.

Video: Highlights from the Bank of Canada's rate hike announcement
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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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