Bank of Canada forges ahead with rate hike as economy surges

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Bank of Canada forges ahead with rate hike as economy surges

On July 12, the bank raised rates for the first time in nearly seven years. They added the central bank might also want to gauge market reaction to Federal Reserve plans to shrink its balance sheet, and contain any further upward move in the value of the Canadian dollar, which threatened to weigh on export growth.

Yet, there was an introduction of cautionary language, and new worries about financial market developments, that weren't in the last rate decision and suggests the central bank isn't quite ready to declare victory on the economy totally eliminating its slack.

"What they are saying to me is they are leaving the door open to futurehikes", said Derek Holt, head of capital markets economics at Bank of NovaScotia in Toronto.

Rai said the odds of another rate hike this year have shot up, and the loonie is likely headed above the 83-cent mark.

Meanwhile, signals from senior Federal Reserve officials have clouded the outlook for rates in the USA with concerns inflation hasn't picked up steam as previously expected.

"The Bank made very little attempt to push back against the strength of the Canadian dollar and also very little attempt to suggest that this is merely (removing) two insurance cuts and then we are on hold for a while", said Bipan Rai, senior macro strategist at CIBC Capital Markets, referring to a pair of 2015 rate cuts meant to combat the effect of plunging oil prices.

"The global economic expansion is becoming more synchronous, as anticipated in July, with stronger-than-expected indicators of growth, including higher industrial commodity prices", said the Bank, but it noted that "significant geopolitical risks and uncertainties around worldwide trade and fiscal policies remain, leading to a weaker U.S. dollar against many major currencies".

Future policy will be determined by evolution of the economy with close attention paid to the sensitivity of the economy to higher interest rates given elevated household indebtedness.

In its statement, the bank also said headline and core inflation have seen slight increases since July, largely as expected. As of June 30, or the end of the second quarter, Canada's economy expanded 3.7% on a one-year basis, or best among Group of Seven economies.

Analysts are busily upgrading their forecasts in the wake of last week's bullish economic data and Wednesday's interest rate hike.

In a statement, the bank said solid employment and wage growth led to strong consumer spending, while the key areas of business investment and exports also improved. However, significant geopolitical risks and uncertainties around worldwide trade and fiscal policies remain, leading to a weaker USA dollar against many major currencies.

Investors anxious that the sharp appreciation of the Canadian dollar would hurt prospects for producers of commodities priced in USA dollars. Compared with a basket of other currencies, the Canadian dollar has climbed just 1.1%, Mr. Rai said.

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