Bank of Canada raises key interest rate target to 1.5 per cent

Stephen Poloz

"Canada's economy continues to operate close to its capacity and the composition of growth is shifting", said the BOC.

Looking ahead, the bank predicts Canadian growth will continue to see bigger contributions from exports and business investment, which were both stronger than expected in the first three months of the year.

For one, Poloz said the bank can't make policy decisions based on "hypothetical scenarios".

The bank said US steel and aluminum tariffs imposed in June and retaliatory countermeasures by Canada in July would trim exports, imports and economic growth, and boost inflation, but strong global demand and higher commodity prices were offsetting the tariff headwind. According to ratehub.ca, a mortgage worth $400,000 amortized over 25 years with a 5-year variable rate of 2.50 per cent, will now cost $50 per month or $600 per year.

If the trade dispute deteriorates further, resulting in something as damaging to the economy as auto tariffs, hiking the interest rate now would also give Poloz more flexibility to lower it down the road, if necessary.

It was reasonable to think at the beginning of the year that the unknowns surrounding NAFTA talks could pause business investment and lead to a decline in activity, he said.

It expects real gross domestic product to grow 2.2 per cent in 2019, up from its April call of 2.1 per cent, and by 1.9 per cent in 2020, compared with its previous prediction of 1.8 per cent. The economy's growth projection for this year remains at two per cent, the bank said.

Poloz also signaled he was comfortable with how financial markets were interpreting the central bank's message, noting the hike was "highly anticipated".

Recent signals from the Bank of Canada governor, combined with strong economic data, have experts widely predicting Poloz will raise his trend-setting rate Wednesday from its current level of 1.25 per cent. Inflation ran at a 2.2-per-cent pace in May, slightly above the Bank's target of 2 per cent. The Bank estimates that underlying wage growth is running at about 2.3 per cent, slower than would be expected in a labour market with no slack.

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