Nicholas Wall, portfolio manager, Old Mutual Strategic Absolute Return Bond Fund, Old Mutual Global Investors, has commented after the Bank of Canada (BoC), bucking the cautious trend prevalent among other major developed-market central banks, hiked interest rates from 0.75% to 1.00% on Wednesday.
"Canada has been experiencing a period of above-trend growth, underlined by 4.5% annualised GDP expansion in the second quarter, with more timely data suggesting that economic momentum remains strong. The BoC sees the composition of growth as broad-based and self-sustaining, despite some cooling in the housing market.
This backdrop appears to have strengthened the central bank’s view that the output gap has all but closed, meaning it was prepared to tighten policy despite core inflation running about 0.5% below its target.
Canada is back to a more traditional business-cycle environment, with endogenous factors having greater influence over trend inflation; as such, it no longer needs to obsess over its exchange rate. If this becomes symptomatic of central bank thinking, markets are likely to become very interesting. The European Central Bank’s September policy decision should be a great test case.
A further rate hike could be on the table for the BoC, in our view, but it will depend on a number of factors:
- The Canadian dollar still exudes some influence over inflation and it is already up over 9% in the year to date vs the US dollar, with the US is its biggest trading partner. The BoC acknowledged that a lot of the adjustment is down to broad weakness in the greenback, but Canadian policymakers could become more hesitant if the pace of appreciation continues.
- It will want further proof that inflation is returning to target.
- Households are indebted, with very little deleveraging since the crisis, and house prices are elevated. The economy is very susceptible to tighter financial conditions, so the BoC will carefully monitor the impact of the rate increase."