The Bank of Canada is continuing to ratchet up interest rates in spite of the worsening tariff showdown between the United States and its main trading partners.
The central bank increased its benchmark interest rate to 1.5 per cent from 1.25 per cent on Wednesday – a widely expected fourth hike in the past 12 months. The move, which immediately triggered matching rate increases on mortgages and other loans at various financial institutions, takes the central bank’s key rate to its highest level in nearly nine years.
Speaking to reporters, Bank of Canada Governor Stephen Poloz made a strong case for pushing rates even higher in the months ahead. Even with the trade uncertainty, he insisted the economy is “in a good place,” with companies running at full tilt and inflation close to the bank’s two per cent target.
“Higher interest rates will be warranted to keep inflation near target,” Mr. Poloz said.
In a communiqué accompanying the rate decision, the central bank said it would continue to take a “gradual approach” to future hikes, guided by incoming economic data.
Mr. Poloz acknowledged the trade situation could take a turn for the worse, particularly if U.S. President Donald Trump makes good on his threat to impose tariffs on imported vehicles and parts.
But the central bank can’t make interest-rate decisions based on what may happen, he said. Indeed, Mr. Poloz argued that monetary policy is “ill-suited” to deal with the fallout from an escalating trade war, which could stall growth, depress the Canadian dollar and spark inflation.
“Monetary policy by itself could not undo the long-term damage to jobs and income that could result from rising protectionism,” he added.
There is still a lot of uncertainty surrounding the pace and timing of future rate increases promised by the bank.
People should not assume the Bank of Canada will suddenly give up on rate hikes even if the trade war escalates, Bank of Nova Scotia economist Derek Holt pointed out. Rather, he said the bank is more likely to be guided by growth and inflation.
Mr. Poloz’s comments, the rate-hike statement and the bank’s latest forecast all point to a central bank that is “committed to a rate hike cycle,” but also ready to respond to evolving events, Toronto-Dominion Bank economist Brian DePratto said in a research note.
Many economists expect three or four more rate increases by the end of 2019, keeping the Bank of Canada in step with the pace of rate hikes in the United States. At 1.5 per cent, the benchmark rate is still well below its estimated “neutral” level of 2.5 per cent to 3.5 per cent – the point where rates neither heat up the economy nor put the brakes on growth.
The Bank of Canada acknowledged on Wednesday that the hit to the Canadian economy from mounting trade turmoil is likely to be larger than it anticipated in earlier forecasts.
“The possibility of more trade protectionism is the most important threat to global prospects,” the bank said.
The U.S. President said this week that he intends to go ahead with tariffs on another US$200-billion of Chinese goods. China warned it will respond in kind, ratcheting up a potentially destructive showdown between the world’s two largest economies. Mr. Trump is also threatening tariffs on imports of cars and parts from Canada and other countries.
Nonetheless, the Bank of Canada insisted the overall impact of trade tensions is still manageable, given the overall strength of the economy. “Although there will be difficult adjustments for some industries and their workers, the effect of these measures on Canadian growth and inflation is expected to be modest,” the bank said.
The combination of tariffs already imposed and continuing trade uncertainty will knock 0.6 per cent off the level of gross domestic product by the end of 2020, according to the bank’s quarterly Monetary Policy Report, also released Wednesday.
The bank pointed out that the combination of higher oil prices – now at roughly US$71 a barrel – and stronger U.S. growth are mitigating the effects of trade uncertainty.
But the bank’s estimate of the trade fallout does not take into account the U.S. threat to impose additional duties on imported vehicles and parts – a move the bank warns would cause “large negative spillovers” on consumer spending and business investment across the Canadian economy.
So far, the United States has imposed tariffs on newsprint, softwood lumber, steel and aluminum – representing 4.1 per cent of Canadian exports. Ottawa has responded with retaliatory tariffs on U.S. imports.
Over all, the bank expects Canada’s economy to grow 2 per cent in 2018, 2.2 per cent next year and 1.9 per cent in 2020. That’s virtually unchanged from its previous forecast, issued in April.