At its meeting on the 11th of July, the Bank of Canada raised its key interest rate from 1.25% to 1.50%. Remember that back in the first quarter of the year, BoC Governor Steven Poloz announced that the regulator would look at raising interest rates again in the summer depending on consumer inflation figures. And so, Poloz has made good on his promise. Interest rates have been raised in line with market expectations. As such, the trend, or rather era, of loose monetary policy is at an end, which had been in place for seven years and only started to be overturned in 2017. In January this year, Canada’s key rate was raised from 1% to 1.25%, with several experts strongly believing that it would remain at this level. Now, however, we can safely say that the Canadian regulator has transitioned to a tight monetary policy.
The main reason behind the BoC’s decision was undoubtedly inflation. While consumer inflation in Canada is currently at its target level of 2%, the regulator has projected inflation to reach 2.5% in the second half of 2018. However, the BoC also expects inflation to slow down in 2019 and return to 2%. Regardless, the Canadian regulator has warned of more potential rate hikes before the end of the year.
The BoC considers the recent high oil prices a boon to the Canadian economy, first and foremost for the oil and gas sector, but they could also have an effect on the rate of inflation. While we believe that there is a possibility of a trade dispute between Canada and the US, it may only have a limited effect on Canadian inflation and economic growth. The hike in interest rates could push the Canadian dollar up against the greenback. On the 11th of July, however, after the BoC’s decision, the US dollar jumped 0.8% against the loonie in response, but the Canadian dollar still has the potential for growth thanks to high oil prices as well as news that further rate hikes are expected in the future. The USD/CAD pair will most likely trade within a range of 1.308 – 1.230. I reckon that the BoC’s decision to raise interest rates could become a model for other central banks around the world that are also set on tightening monetary policy, most of all the US Fed and Bank of England, which will hold their next meetings on monetary policy on the 1st and 2nd of August respectively.
