Bank of Canada hikes key interest rate to 1.25%

A new survey suggests that one in five Canadians has a credit card balance larger than their savings accounts

Canadians will have to pay more to borrow money from banks after the country's central bank raised its key lending rate by a quarter percentage point to 1.25 per cent on Wednesday despite looming uncertainty over the future of the North American Free Trade Agreement (NAFTA).

The hike means that borrowers who have variable rate mortgages, credit lines and loans will have to pay more.

"Uncertainty about the future of NAFTA is weighing increasingly on the outlook", the bank said.

This is the third hike since last summer.

At a press conference, Bank of Canada governor Stephen Poloz expanded on that thought, telling reporters it is hard to come up with a firm number to gauge the impact of something as dramatic as implementing tariffs into a trade relationship that had previously been open.

Moving forward, the bank predicted household spending and investment to gradually contribute less to economic growth, given the higher interest rates and stricter mortgage rules.

The bank now expects Canada's economy to expand by 2.2 per cent this year and 1.6 per cent in 2019. We concur with the Bank's assessment that "some accommodation will likely be needed to keep the economy operating close to potential and inflation on target" and we believe that the Bank will need to slow the pace of rate hikes in 2019 (we now have the overnight rate holding at 2.25%, below the 3.00% mid-point of the Bank's estimated neutral rate range, largely reflecting the impact of higher rates on high household debt).

Poloz raised rates in July and September in response to a surprisingly strong economic run that began in late 2016.

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Canada is now renegotiating the North American Free Trade Agreement (NAFTA) with the United States and Mexico. On the other hand, the bank predicted that Canada will see a small benefit from the recent USA tax changes thanks to increased demand.

The bank slightly increased its predictions for 2018, up to 2.2 per cent from 2.1 per cent.

"Today's rate hike was a rear-view mirror move", CIBC economist Avery Shenfeld said of the bank's decision to hike, but the concern over NAFTA "hints that the view out the front window isn't quite as sunny".

But while global commodity prices continue to grow, the benefits to Canada are being diluted by wider spreads between benchmark world and Canadian oil prices, the bank said.

"We can't just relax and assume that it would be a small shock", he said.

Overall, the Bank of Canada said slack, or unused capacity, in the labor market has disappeared more quickly than anticipated.

What is your current mortgage rate?

The Bank of Canada's ... more upbeat economic outlook suggests that it will hike rates again later this year, probably in April.

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