Bank of Canada Holds Interest Rates at 1.25 Percent

Bank of Canada Holds Interest Rates at 1.25 Percent

The Bank of Canada announced Wednesday that it will keep its interest rate unchanged at 1.25 percent due to weakness in housing, trade and investment in export-oriented sectors.

But the first quarter of 2018 was weaker than the bank expected due to exports lagging and housing market activity being pulled into late 2017 to get ahead of tighter mortgage regulations that came into effect in 2018.

The BoC expects Canada's GDP, which was 1.3% annualized in Q1, to rebound in the second quarter, resulting in a 2% average growth in the first half of 2018.

On inflation, the bank said temporary downward forces weighing on the rate have largely dissipated.

Scotiabank Capital Markets economist Derek Holt says the Bank of Canada is facing "a conundrum of sorts", in that economic growth has been disappointing as the NAFTA talks progressed, yet wage and price pressures are building. Still, capacity constraints have been limiting export growth.

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Business investment has emerged as the single biggest uncertainty looming over the Bank of Canada's path to higher interest rates. If we saw some clarity in the next few months on NAFTA, and/or some policy response from the Canadian government to the USA tax cuts, it would open the door for businesses to accelerate their spending on new capacity.

That means that even with the stronger growth outlook, the economy has more room to grow without generating inflationary pressures. It sees growth of 2 per cent this year and 2.1 per cent in 2019, a significant revision from a previous estimate of 1.6 per cent.

Canadian domestic consumption remains robust, supported by strong labor income growth.

The Canadian economy is operating at close to capacity.

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It now forecasts potential output to grow by 1.8 percent in 2018 and 2019, before accelerating to 1.9 percent in 2020.

The main reason the output gap widened, the Bank of Canada said, was because businesses have been investing more than previously believed in expanding their capacity. That growth is expected to ease from about 3.75% in 2018 to about 3.5% in 2020.

The report also gave an update to the important economic risks as seen by the central bank.

Poloz is trying to fine-tune a return of interest rates back to more normal levels, hoping to raise them just enough to prevent inflation from creeping up, and not so quick as to trigger an unwanted slowdown.

Importantly, Mr. Poloz took pains to remind everyone that the Bank of Canada's 2-per-cent inflation target is the mid-point of the bank's target band of 1 per cent to 3 per cent - and that inflation had resided below that mid-point for a very long time. "The statement accompanying the decision may have had a hint of hawkishness to it, but the details of the Monetary Policy Report were decidedly dovish", noted TD Economics in a research report.

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