Thursday, 13 December, 2018

Bank of Canada Raises Benchmark Rate, Warns on Nafta Risk

Bank of Canada Raises Benchmark Rate, Warns on Nafta Risk Bank of Canada Raises Benchmark Rate, Warns on Nafta Risk
Nellie Chapman | 18 January, 2018, 14:09

The Canadian dollar changed little against the greenback in a Wednesday's seesaw session after the Bank of Canada hiked interest rates and indicated confidence in the outlook for the economy, but sounded a cautious tone on the future of NAFTA.

The increase is expected to encourage Canada's major banks to once again raise their prime lending rates, a move that would drive up the cost of variable-rate mortgages and other variable-rate loans. Growth is expected to remain above potential through the first quarter of 2018 and then slow to a rate close to potential for the rest of the projection horizon. The statement raised questions about how quickly the bank will raise the rate from here.

At the very least, the drama around NAFTA may give the central bank some pause, Bank of Montreal economist Robert Kavcic said. The latest increase follows two hikes in July and September.

Canada is now renegotiating the North American Free Trade Agreement (NAFTA) with the United States and Mexico.

In particular, there are signs of increasing momentum in the USA economy, Canada's largest trading partner, which will be boosted further by recent tax changes, the bank said. The United States buys about three-quarters of Canada's exports.

"I believe it would be net negative for both Canada and for the USA", he said of the theoretical demise of NAFTA, "but to actually quantify that is very hard, because every sector is affected differently". The level of business investment is expected to be 2% lower by 2020 than what would otherwise be the case due to trade-policy uncertainty, the Bank of Canada estimated. On the other hand, it predicted Canada to see a small benefit from the recent USA tax changes, thanks to increased demand. It also warned recent USA tax cuts - bringing the corporate rate down to 21% from 35% - could "reinforce these uncertainty effects", with companies opting to shift planned capital expenditures from Canada to the U.S.

This calculator takes your current mortgage rate, and assumes it will rise by 0.25 per cent to match the recent hike from Canada's central bank.

What's more, despite the positive run of labour market data, wage growth remains weaker than the Bank had expected.

Although Canadian's competitiveness would be affected, the bank is having their base-case point of view reasoned by the impact of the likely increase of the USA economy that will increase demand which can aid Canada and the impact of Trump's move to have corporate taxes put to an end. Further, the central bank said it is monitoring the extent to which stronger demand and investment are boosting the level of potential gross domestic product, or the amount of growth that can unfold before inflationary pressures are triggered.

"Recent data have been strong, inflation is close to target and the economy is operating roughly at capacity", the bank said in the announcement.