MNI POST-BOC: Bank of Canada Raises Rates, Removes "Gradual"

By Yali N'Diaye

     OTTAWA (MNI) - A hawkish Bank of Canada raised its benchmark interest rate

by 25 basis points as expected and replaced a reference to a "gradual" pace of

future hikes with a declaration that rates should rise to a "neutral" level.

     While U.S.-China tensions and still elevated household debt levels remain

as risks, the BOC drew confidence from a preliminary U.S.-Mexico-Canada

preliminary trade agreement and a moderation in household credit growth as it

boosted its overnight rate target to 1.75%.

     The BOC estimates that neutral lies somewhere between 2.5% and 3.5%,

leaving room for as much as 175 basis points in further rate hikes. Governor

Stephen Poloz told a press conference Wednesday that monetary policy remained

"quite" stimulative.

     The BOC has raised rates five times, by a cumulative 125 basis points,

since July 2017, including 75 basis points this year, under its gradual

approach. The first two hikes reversed 50 basis points in cuts made in 2015 in

response to an oil price shock.

     The central bank projects GDP growth of 2.1% in 2019, the same level as

this year, and for the economy to become better balanced.

     The trade deal with the U.S. and Mexico clears an important cloud over

Canada's economic outlook. The BOC also expects wage growth, still around a

"moderate" 2.3%, to pick up in coming quarters.

     Subdued wage growth, despite intensifying reports of labor shortages and

historically low unemployment rates, has puzzled officials and has been among

factors leading the BOC to stress the possibility of ongoing economic slack.

     The BOC signaled that the decline in Western Canada Select crude prices was

likely temporary in nature, unlike the global oil price shock in 2014. The

spread with U.S. benchmark West Texas Intermediate "will likely narrow in the

near term as some temporary headwinds are resolved," the BOC said, although

transportation constraints in Canada could take longer to address.

     But the BOC stressed Wednesday that although household credit growth

continues to slow and housing activity is stabilizing following a weak start to

the year, indebtedness remains elevated and it is necessary to monitor how the

economy adjusts to higher rates.

     And, while the USMCA deal reduces uncertainty, it has yet to be ratified by

the three jurisdictions. Mutual U.S. and Canadian tariffs on steel and aluminum

remain in place.

     Global trade tensions also have the potential to escalate, with a fallout

that "could be more severe than what is included in the projection." The risk is

increased by the fact that, unlike the renegotiation of the North American Free

Trade Agreement, there is no clear process associated with the US-China dispute.

     While these are powerful factors that may restrain the BOC, a resolution of

the U.S.-China tensions would be an important upside risk to economic prospects.

Household indebtedness, however, is a structural issue that will take years to

resolve.

     "Yes it's possible that the pace could be a bit faster, but it's also

possible that it could be a bit slower, because as I said, the risks are two

sided and we'll be decidedly data dependent," Senior Deputy Governor Carolyn

Wilkins told the press conference. "We're hoping that participants in the

markets and households will be doing the same thing."

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

[TOPICS: M$C$$$,MT$$$$,MX$$$$]