The Bank of Canada raised interest rates on Wednesday, surprising many, and said future moves will be guided by economic data, financial market developments and the sensitivity of indebted households to higher rates.
The 25-basis-point increase to 1 percent followed a hike in July and puts Canada ahead of the curve in returning borrowing costs to more normal levels after they were slashed due to the 2007-2009 financial crisis. While the U.S. Federal Reserve has begun tightening, its pace has been slower.
The Bank of Canada said the hike was warranted given unexpectedly strong GDP growth in the second quarter and the bank’s view that growth is becoming more broadly based and self-sustaining, with robust consumer spending and solid job and income growth.
Future rate moves “are not predetermined” and will be guided by economic data and financial market developments “as they inform the outlook for inflation,” the bank said in a statement.
“Particular focus will be given to the evolution of the economy’s potential, and to labor market conditions. Furthermore, given elevated household indebtedness, close attention will be paid to the sensitivity of the economy to higher interest rates,” it said.
Canadian household debt is near record levels and a recent drop in house sales and prices in Toronto, Canada’s biggest city, has some analysts worried that higher rates will hurt consumers and spur a broader housing market correction.
The central bank said that while inflation remains below the 2 percent target, there has been “a slight increase” in both total CPI and the bank’s core measures of inflation, “consistent with the dissipating negative impact of temporary price shocks and the absorption of economic slack.”
It also noted the recent appreciation of the Canadian dollar, which reflected U.S. trade and fiscal uncertainty and the relative strength of Canada’s economy.
The bank said excess capacity remains in the labor market, and wage and price pressures are “still more subdued” than historically, as is also seen in other countries.
The housing market appears to be cooling in some markets, while there has been more widespread strength in business investment and in exports, the bank noted.
The bank reiterated that significant geopolitical risks and uncertainties around international trade and fiscal policies remain, leading to a weaker U.S. dollar against many major currencies.
“In this context, the Canadian dollar has appreciated, also reflecting the relative strength of Canada’s economy,” it said.
While many economists had expected the bank would wait until its October meeting to hike again, a significant minority in the market had bet on a move on Wednesday.