North American stocks up, loonie down following Bank of Canada rate hike

North American stocks up, loonie down following Bank of Canada rate hike

North American stocks up, loonie down following Bank of Canada rate hike

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 Bank of Canada today increased its target for the overnight rate to 1 1/4 per cent. "It's not that we were arguing but we were debating the pros and cons ... the big cloud over the forecast, as well as our discussion, is NAFTA", Governor Stephen Poloz told a news conference. However, it cautions about the substantial improbability linked to the possible changes of policy by the United States, which is its major dealing partner.

In particular, there are signs of increasing momentum in the US economy, Canada's largest trading partner, which will be boosted further by recent tax changes, the bank said.

The central bank's tone, however, was more dovish than many economists were expecting. Exports have been weaker than expected although, apart from cross-border shifts in automotive production, there have been positive signs in most other categories.

The global economy continues to strengthen, with growth expected to average 3 1/2 per cent over the projection horizon.

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In explaining the hike, the bank said in a statement that inflation was close to target and the economy was operating roughly at capacity. The report also said new, or "greenfield", foreign direct investment into Canada has fallen since mid-2016 - a possible impact of the trade uncertainty. Further, the central bank said it is monitoring the extent to which stronger demand and investment are boosting the level of potential gross domestic product, or the amount of growth that can unfold before inflationary pressures are triggered. It predicted Canada's high levels of household debt would amplify the effects of higher interest rates on consumption. The increase followed hikes in July and September.

Subdued exports are the top risk in light of NAFTA uncertainty and recent imposition of tariffs by the U.S. Also, more rapid potential output, stronger U.S. growth and more robust consumer spending were seen as risks.

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

The next rate decision is expected on March 7. Prior to the Bank of Canada's move, their rates were all 3.2 per cent.

Scotiabank Economics is forecasting 75 basis points of gradual tightening this year spread out throughout 2018, while TD Economics expects a gradual pace of tightening over the next two years of about 25 basis points every six months. Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy's sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.

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