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Economy BoC shifts tone on rate announcement, signalling likely July hike

Canada’s central bank has cleared the way for a July interest rate hike, warning that it will need to act soon to keep inflation from pushing past its 2-per-cent target.

The Bank of Canada kept its key interest rate target unchanged at 1.25 per cent on Wednesday, citing the impact of trade uncertainty, a slowdown in housing activity and mounting “stress” in emerging markets.

The bank’s rate announcement came with a marked shift in tone that seemed to surprise financial markets. Investors drove up the value of the Canadian dollar by more than a full cent, amid mounting expectations of a July rate hike.

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Bank of Canada Governor Stephen Poloz generally does not broadcast future rate moves with explicit forward guidance. But on Wednesday, it’s was what Mr. Poloz and members of the bank’s governing council didn’t say that shifted expectations. The statement accompanying the rate decision dropped two key phrases that have been a staple of the bank’s communication for months. Gone is the reference to being “cautious” about future policy changes. Also absent is the qualifier that higher rates will be needed “over time.”

Related: Higher rates, stricter mortgage rules curbing home prices but debt still a key risk: BoC

Instead, the bank is offering new, more assertive language about where rates are headed now that the economy is running near full capacity.

“Developments since April further reinforce the governing council’s view that higher interest rates will be warranted to keep inflation near target,” the statement said. “Governing council will take a gradual approach to policy adjustments, guided by incoming data.”

The odds of a July rate hike is now just shy of 80 per cent, up from slightly more than 50 per cent on Tuesday, according to Bloomberg’s interest rate probability tracker.

“While we may need a grammarian to distinguish between ‘cautious’ and ‘gradual,’ the message was nevertheless clear: Get ready for another rate hike,” Toronto-Dominion Bank economist Brian DePratto said in a research note.

National Bank of Canada similarly concluded that the statement “kicked wide open the door for a July rate hike.”

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Mr. Poloz has insisted in the past that his use of words such as “cautious” is not code-language for what the bank plans to do next. But Bank of Nova Scotia economist Derek Holt said the latest statement suggests the central bank has more confidence in its forecast of a strengthening economy and that it is “not making a mistake by tightening monetary policy.”

The bank identified several signs of emerging economic strength, including stronger-than-expected U.S. growth, higher oil prices, more “robust” exports and “solid” labour income growth.

The bank also seemed to play down concerns about the impact that higher rates could have on an already slowing housing market. It said it expects that a recovery in housing activity and consumption would power growth through the rest of the year.

The bank’s next rate decision is on July 11, when it also releases its third quarterly economic forecast of 2018. Many economists expect the bank to raise its key rate to 1.5 per cent on that date and perhaps again before the end of the year.

The Bank of Canada has raised its overnight rate three times since last June, each time by a quarter of a percentage point. It has been on hold since January, in large part because of the uncertainty swirling around the future of the North American free-trade agreement with the United States and Mexico.

The threat that President Donald Trump might pull the United States out of NAFTA has receded. But so too has the chance of a near-term agreement as the three countries remain far apart on several key issues, including North American content rules for autos and the dispute-settlement regime.

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The Canadian economy has been growing steadily in recent months and inflation is now at or above 2 per cent, based on the various price benchmarks the central bank tracks. Under its mandate, the central bank uses interest rates as a tool to keep inflation near 2 per cent, pushing rates higher when prices exceed that threshold.

“Inflation in Canada has been close to the 2-per-cent target and will likely be a bit higher in the near term than forecast in April, largely because of recent increases in gasoline prices,” according to the statement. “Core measures of inflation remain near 2 per cent, consistent with an economy operating close to potential.”

The bank’s April forecast had called for inflation to be running at a 2.1-per-cent annual pace in the first quarter, along with economic growth of 1.3 per cent. Both forecasts now appear a touch low.​

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