Bank of Canada raises interest rate for first time in 7 years from 0.50% to 0.75%

Bank of Canada raises interest rate for first time in 7 years from 0.50% to 0.75%

Bank of Canada Anticipates a Growth in Economy by 2.8% in 2017

In anticipation of a robust economic growth in 2017, the Bank of Canada, the central bank of the country, has announced a raise of 0.75% on its key interest rate. This rise in the cost of borrowing is the first of its kind in the past seven years. The bank has also announced a rise in the target overnight rate to 0.75%, which is a quarter of a percentage point rise from 0.5%.  The overnight rate is the rate at which the main banking organizations make one-day loans among each other.

The Bank of Canada has described household spending as the key reason behind the growth of the economy, and “as a result, a significant amount of economic slack has been absorbed.” Experts also expect that the remaining slack as predicted in the bank’s April  Monetary Policy Report is likely to be covered by the end of the year.

Increase in the Rates of Interest Not Entirely Unexpected

In the last few weeks, senior officials at the Bank of Canada have hinted at the improving economy in several speeches and interviews.

Stephen Poloz, governor at the Bank of Canada, addressed a press conference on Wednesday in Ottawa. He revealed that the bank is aware of that inflation is lagging behind the declared target of 2%, but also predicted that the low inflation rates is a temporary phase. For this reason, the bank has gone ahead with its plans to raise the interest rates.

Bank of Canada Governor Stephen Poloz

“It is worth remembering that it can take 18 to 24 months for a monetary policy action to have its full effect on inflation. This means that central banks must target future inflation by anticipating future deviations from target,” Poloz said.  He added that “It is about where we expect inflation to be,” and that the bank is estimating a 2%  “modest overshoot” of the targeted inflation in 2019.

Poloz also said interest rates are still very low, and that the economy can handle this change. “People need to understand that in the full course of time I don’t doubt that interest rates will move higher, but there’s no predetermined path in mind at this stage. Any future changes to the central bank’s key interest rate will depend on economic data in the months ahead,” Poloz said.

More Increments Expected Soon

Craig Wright, the chief economist at the Royal Bank of Canada, said he thought the bank’s move may be an indication of a rise in the interest rates on a long-term basis. “I think it’s the Bank of Canada having confidence that the breadth and durability of the expansion in Canada can sustain these small increases in interest rates,” he said. “We’re going to see more [rate hikes] as we move forward, assuming growth holds up.”

Janet Yellen at the Federal Reserve is also looking at higher rates. “The Federal Reserve will also likely increase rates in [the fourth quarter]. Look for a slow crawl upward in interest rates from both central banks in 2018,” Yellen said.

The Canadian Economy is Performing Exceptionally

Overnight rates fixed by the Bank of Canada have remained unchanged since August 2010 when they went up to 1%. Once Poloz assumed the position of the governor of the bank, over the next five years up to 2015, the rates dropped twice to 0.5% . They have remained at this position until Wednesday when the bank announced a hike.

The bank has also announced estimates of a 2.8% growth in the economy and real gross domestic product (GDP) in 2017. These are more favorable conditions as compared to the 2.6% estimates of April 2017. Forecasts for the coming years stand at a moderate 2% for the year 2018 and 1.6% for 2019.

Impact on Consumers

As a fallout of the rising interest rates, consumers can expect to pay more for lines of credit and variable-rate mortgages. Additionally, by early Wednesday afternoon, the value of the Canadian dollar has appreciated with a rise of 0.93 of a cent at 78.32 cents US.