The Bank of Canada is taking a breather from its efforts to push up interest rates as it watches the fallout from the country’s trade showdown with the U.S.
The central bank opted to leave its key rate at 1.5 per cent Wednesday in spite of unexpectedly good economic conditions this summer.
“The bank is . . . monitoring closely the course of NAFTA negotiations and other trade policy developments, and the impact on the inflation outlook,” the bank said in a statement.
The bank added that “elevated trade tensions” remain a key risk to the global economy and are already depressing some commodity prices.
Canadian and U.S. negotiators resumed talks in Washington Wednesday aimed at renegotiating the North American Free Trade Agreement. The two sides are deadlocked on key issues, including U.S. demands to open up Canada’s dairy market and Ottawa’s insistence on retaining an independent dispute settlement system. Canada is already facing U.S. tariffs on steel and aluminum, with more threatened on the auto sector.
The bank readily acknowledges that economic conditions are ripe for more rate hikes, in spite of the trade uncertainty. The consumer price index hit 3 per cent in July – a surprise spike that the bank attributed to higher airfares. Economic growth was also hotter than expected in the second quarter, at a 2.9 per cent annual clip.
The bank also pointed out that household debt levels are coming down, the housing market is starting to stabilize and both business investment and exports are growing “solidly.”
Many economists are betting that the central bank will resume hiking at its next rate-setting announcement on Oct. 24, when the bank is due to release its next quarterly economic forecast.
“Barring a major shock, an October rate hike looks like a pretty safe bet, but after that the picture becomes murky,” Toronto-Dominion Bank economist Brian DePratto said in a research note.
A NAFTA deal in the next few weeks could perk up growth prospects for Canada, and force the Bank of Canada to speed up the pace of future rate hikes, Mr. DePratto pointed out.
The Bank of Canada will get an opportunity to further explain its thinking on rates on Thursday, when senior deputy governor Carolyn Wilkins is slated deliver a speech in Regina and takes questions from reporters.
The central bank has raised rates four times since mid-2017, most recently in July. And it said Wednesday that recent economic data reinforce its view that higher rates will be needed to keep inflation near the bank’s two per cent target.
“We will continue to take a gradual approach guided by incoming data,” the bank said, repeating a now familiar refrain.
The statement pointed out that both inflation and growth will slow a bit in the months ahead. In spite of July’s spike in prices, the bank said its core measures of inflation remain near two per cent and wage growth is moderate.
The bank said it expects economic growth to slow temporarily in the third quarter due to “fluctuations” in energy production and exports.
A key challenge for the bank is that low interest rates are driving consumer and business activity higher even though the economy is already at near full capacity and inflation is on target.
The Bank of Canada estimates that its neutral interest rate is roughly 3 per cent – a level that neither revs up the economy nor slows it down. At 1.5 per cent now, the bank’s key rate is still well below that threshold.