OTTAWA — The Bank of Canada kept its key interest rate unchanged at 1% on Tuesday but for the first time since the recession it said it would eventually have to lift borrowing costs if economic growth continues. “To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be eventually withdrawn, consistent with achieving the 2% inflation target,” it stated. “Such reduction would need to be carefully considered. It did not say whether “eventually” meant the next rate increase would be in July, September or beyond, but its statement was more hawkish than previous ones, which only said that any future hikes “would need to be carefully considered.”
The central bank now sees underlying inflation as only “relatively subdued” rather than “subdued” as in previous statements, but it did not change its overall outlook for inflation. It repeated that the persistent strength of the Canadian dollar “could create even greater headwinds for the Canadian economy” and dampen inflation. Temporary supply chain disruptions from Japan will sharply restrain growth in the second quarter but this should be unwound afterward, it said.
It said the U.S. economy continued to grow modestly and European growth was maintaining momentum, but it said risks to peripheral European economies had increased. The currency rose as high as $1.0325, up from $1.0285, immediately before the announcement. It was the Canadian dollar’s strongest level since May 20.
The central bank became the first in the Group of Seven advanced economies to tighten monetary policy following the global financial crisis, hiking three times from June-September last year but pausing since then due to the weak global recovery. There has been no consensus among market players on when the bank would resume the tightening cycle but July had recently been ruled out by most as a possibility.
Three of Canada’s largest commercial banks pushed back their rate hike expectations to September from July over the past two weeks. Thirty-five of 43 forecasters surveyed by Reuters last week predicted the next rate hike would be in the third quarter, implying a move in either July or September, or both. Overnight index swaps, which trade based on expectations for the key central bank policy rate, showed investors slightly reducing the likelihood of a rate hike in July, but increasing the odds of tightening in September, October and December. Swaps showed markets see a 94.3 probability the central bank will keep its benchmark rate on hold in July, up from 93.56% just before the rate decision.