The Bank of Canada rises target rate to 1.75%, drops graduality from the outlook

• The Bank of Canda raises the overnight interest rate to 1.75% saying higher rates will be needed to achieve the inflation target.
• The Bank of Canada drops the previous language about gradual rate hikes, says in determining appropriate pace of increases will continue to take into account how the economy is adjusting to higher rates.
• The USD/CAD drops 100 pips past 1.3000 area where the move stabilized after the rate decision.

The Bank of Canada decided to hike the overnight interest rate to 1.75% saying higher rates will be needed to achieve the inflation target while dropped the previous language about gradual rate hikes. The Canadian Dollar rose 100 pips to C$1.3000 in a knee-jerk reaction to the move with the Bank of Canada sounding very optimistic about the growth outlook. The Bank of Canada Deputy Governor Wilkins said the Bank removed reference to the gradual pace of rate hikes "to avoid the impression that we are following a preordained, mechanical policy path".

Most importantly, the Bank of Canada said that new US-Mexico-Canada trade deal will reduce trade policy uncertainty in North America, with the US-China trade conflict weighing on global growth and commodity prices. Canada’s central bank further said the net effect of the US-China trade tensions on Canada would be negative but small, while fallout for the global economy could be more severe than expected.

"The Bank of Canada, like the Federal Reserve is looking for the neutral rate.  The BOC statement said they will judge the proper level by the effect that their increases have on economic activity.  But rate increases have a delayed impact. Is the Canadian economy the same as the last time the bank ventured into neutral territory in 2006?" the FXStreet senior market analyst Joseph Trevisani commented on the rate hike on Wednesday. 

The Bank of Canada said trade tensions between the US and China could have a significant and lasting impact on the global economy estimating that the US-China tariffs, if made permanent, will lower real GDP by 0.2% in the US, by 0.5% in China by end of 2020.
 
The Bank of Canada also expects that US consumer prices would rise by up to 0.2% if tariffs were fully passed on to consumers.

In terms of the domestic economy, the Bank of Canada said it will also pay close attention to global trade policy developments and their implications for the inflation outlook as investment and exports will be dampened by the recent decline in commodity prices, as well as competitiveness challenges and limited transportation capacity.

Nevertheless, the outlook for Canada’s economic growth remained bright with the Bank of Canada expects the Canadian economy to continue to operate close to its potential with the composition of growth is more balanced. 

Bank of Canada raises Q3 GDP forecast to 1.8% from 1.5%, sees Q4 at 2.3% saying the annual growth rate of potential output assumed to average 1.9% over 2018-2020 projection horizon.