BoC Raises Policy Rate 25bp; Prime Follows

The Bank of Canada has announced:

The Bank of Canada today increased its target for the overnight rate to 1 ½ per cent. The Bank Rate is correspondingly 1 ¾ per cent and the deposit rate is 1 ¼ per cent.

The Bank expects the global economy to grow by about 3 ¾ per cent in 2018 and 3 ½ per cent in 2019, in line with the April Monetary Policy Report (MPR). The US economy is proving stronger than expected, reinforcing market expectations of higher policy rates and pushing up the US dollar. This is contributing to financial stresses in some emerging market economies. Meanwhile, oil prices have risen. Yet, the Canadian dollar is lower, reflecting broad-based US dollar strength and concerns about trade actions. The possibility of more trade protectionism is the most important threat to global prospects.

Canada’s economy continues to operate close to its capacity and the composition of growth is shifting. Temporary factors are causing volatility in quarterly growth rates: the Bank projects a pick-up to 2.8 per cent in the second quarter and a moderation to 1.5 per cent in the third. Household spending is being dampened by higher interest rates and tighter mortgage lending guidelines. Recent data suggest housing markets are beginning to stabilize following a weak start to 2018. Meanwhile, exports are being buoyed by strong global demand and higher commodity prices. Business investment is growing in response to solid demand growth and capacity pressures, although trade tensions are weighing on investment in some sectors. Overall, the Bank still expects average growth of close to 2 per cent over 2018-2020.

CPI and the Bank’s core measures of inflation remain near 2 per cent, consistent with an economy operating close to capacity. CPI inflation is expected to edge up further to about 2.5 per cent before settling back to 2 per cent by the second half of 2019. The Bank estimates that underlying wage growth is running at about 2.3 per cent, slower than would be expected in a labour market with no slack.

As in April, the projection incorporates an estimate of the impact of trade uncertainty on Canadian investment and exports. This effect is now judged to be larger, given mounting trade tensions.

The July projection also incorporates the estimated impact of tariffs on steel and aluminum recently imposed by the United States, as well as the countermeasures enacted by Canada. Although there will be difficult adjustments for some industries and their workers, the effect of these measures on Canadian growth and inflation is expected to be modest.

Governing Council expects that higher interest rates will be warranted to keep inflation near target and will continue to take a gradual approach, guided by incoming data. In particular, the Bank is monitoring the economy’s adjustment to higher interest rates and the evolution of capacity and wage pressures, as well as the response of companies and consumers to trade actions.

As usual there are no details of how the voting went or any capsule description of the rationale for such dissent, as is routinely provided by professionally managed central banks such as the US Federal Reserve. It’s a pity that members of the grandiosely named Governing Council are so insecure!

Market reaction was muted:

The Canadian dollar weakened to a more than one-week low against its U.S. counterpart on Wednesday as broad-based gains for the greenback offset an interest rate hike and the prospect of further tightening by the Bank of Canada.

The U.S. dollar rose as the market put aside trade tension fears and focused on an expectation-beating inflation report, which increased prospects that the Federal Reserve will raise interest rates two more times this year.

“This U.S. dollar move offsets and even more so the somewhat hawkish BoC hike,” said Greg Anderson, global head of foreign exchange strategy at BMO Capital Markets in New York.

The Bank of Canada raised its benchmark interest rate by 25 basis points to 1.50 per cent, the fourth hike since last summer.

Money markets see a nearly 70 per cent chance of further tightening by December.

The Big Banks hiked prime. Sadly, we do not know what has been done with the banks’ top secret internal primes or the spreads to Prime that the average customer might see on his renewal notice.

Details are:

3 Responses to “BoC Raises Policy Rate 25bp; Prime Follows”

  1. fed says:

    I know this question is not about interest rates, but I don’t know where else to post it on your site. Sorry.

    I am wondering if preferred shares should be included in portfolio sector distribution analysis, or if they are so different that they should be in their own category, like bonds and GICs. For example, should CU preferred shares count as exposure to the utilities sector?

    Thanks in advance.

  2. jiHymas says:

    Like so many things in this business, it depends.

    You will be aware that fixed income instruments, whether bonds, GICs or preferred shares, will all have differing credit qualities which can be estimated by the investor or, at the very least, be approximated by looking up what the credit rating agencies have to say.

    The very peak of credit quality will be a strong, stable government; while nothing can be considered absolutely certain in this world, you can be as sure that the government’s commitments will be met as you can be of anything else. At the other end of the scale is a very poor quality company, inches from bankruptcy, which could default on their obligations at the drop of a hat.

    High-quality issues will have essentially no sectoral allocation implications for a portfolio; low quality issues are essentially equities and a dollar’s worth exposure to the bond is no different from this perspective than a dollar’s worth of equity.

    I don’t have any firm views on just how these general remarks can be translated into a portfolio plan. However, I suggest that as a rule of thumb:

    Investment Grade: factor of 0.25 sector weight
    Pfd-3 : 0.5
    Lower: 1.0

    So by this, for instance, we could say that $4-worth of investment grade fixed income is the same, for sectoral allocation purposes, as $1-worth of equity.

    And note that this is just a suggestion based on general experience and I have no hard data to back this up.

    You could test it in various ways. For instance, you could do a simple correlation of returns between equities and bonds (for a single company) and say that the slope of the relationship is the factor. Or you could be more general and use credit rating agency transition tables to simulate upgrades and downgrades and use generic spreads to determine the possible price effect of these transitions. In both these cases, however, you would be using market sensitivity, which is likely to be different from “real” sensitivity.

  3. fed says:

    That is great and makes sense to me. Thank you so much yet again!

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