Yesterday, the Bank of Canada (BoC) met market expectations by raising the target overnight interest rate by 25 basis points to 0.75%. Although investors were broadly expecting an increase, it is notable as it marks the first rate hike in about seven years.
The BoC’s assessment is that growth in Canada has broadened across industries and regions. The Central Bank believes the growth is sustainable and upgraded its growth forecasts for 2017 from 2.6% to 2.8%. Overall, the announcement was viewed as being relatively “hawkish” (being in favour of higher rates) and strongly hints at further increases in the near future.
Canadian government bond yields and the loonie rose after the hike on speculation that the BoC will raise rates again later this year. Since May, the CAD has rallied 8% against the USD.
The BoC is no doubt aware of the delicate act it has to perform. Raising rates increases the risk prospects of a growing competitive wedge between Canadian and the U.S and an overextended housing market. Major banks have already increased their prime rate, and anyone with a variable mortgage will now have higher lending costs. Those with fixed-rate mortgages will likely have higher lending costs at renewal.
The action taken by the BoC is part of a coordinated tightening effort among major central banks. Given where we are now, the trend globally will be to slowly increase rates over time. This will in turn lead to higher bond yields. In the short-term, managers are likely to adapt a cautious approach in their portfolios.