The central bank raised interest rates to 0.75 percent from 0.50 percent on Wednesday, its first hike in seven years. I am still scratching my head trying to figure out why?
Inflation figures have eased over recent months, the price of oil hasn’t recovered to the $60 level. Therefore, oil prices will keep headline inflation low. Foreign capital is still leaving the Alberta oil sands seeking cheaper oil production fields in the United States. Alberta’s unemployment rate is falling but it is still over 7 percent, not exactly booming.
The housing sector is responsible for 25% of Canada’s GDP growth. The housing bubble is already showing signs of bursting and household debt is at extremely high levels. Higher borrowing costs will dampen economic growth pushing core inflation further below target. Higher interest rates make mortgages more expensive and Canadians will have less money to spend.
Hedge funds have been shorting the Canadian dollar and our Canadian banks expecting a meltdown in housing. Add low oil prices to the mix and fund managers were betting on a big drop in value of our dollar. Surprise, the Canadian dollar has jump 5% in value against the U.S. dollar. When you add the fact that the United States receives 75 percent of our exports, the increased value of our dollar is going to make our exports more expensive which could further reduce economic growth.
The Bank of Canada’s own projections for economic growth don’t seem to justify increasing interest rates at this point.
“The Bank of Canada now expects the economy to grow 2.8 per cent this year, or faster than the 2.6-per-cent pace it predicted in its April forecast. GDP growth will slow to 2 per cent in 2018 and 1.6 per cent in 2019, the bank said.”
Is the Bank of Canada trying to shock Canadians to curb their appetite for debt financing? Will increasing the value of the Canadian dollar stop foreigners from buying Canadian real estate?
Many economist have made the argument that the two original rate cuts in 2015 were made as insurance to avoid a recession in Canada due to the falling price of oil. That threat has been avoided and therefore the Bank of Canada is justified in taking back those two cuts.
My theory is the Bank of Canada is gambling with a temporary slowdown in economic growth in order to help our government renegotiate NAFTA. Talks will be starting soon with the United States. Keeping our interest rates close to the U.S. rates and a stronger looking Canadian dollar would certainly show good faith during the negotiations.
Where does it go from here?
Despite the housing market, some analysts believe the BOC will announce further rate hikes. Citi analysts predict two rate hikes this year (including Wednesday’s hike) but no more until the second half of next year. BoAML expects another rate hike in January of next year but says such decisions will be “data dependent”.