The Bank of Canada set to raise rates as the first central bank in 2018

With the inflation rate jumping above target in November and employment in Canada strong increases as well, the Bank of Canada is set to hike rates as the first among world’s major central banks in 2018 this Wednesday.

The market is widely expecting the Bank of Canada to deliver the 25 basis points rate hike with the policy rate rising to 1.25%. At the same time, the opinion poll conducted by Reuters among analysts and economists showed another two interest rate hikes in Canada in 2018 with the end-of-the-year policy rate at 1.75%.

While headline inflation overshooting the target in short-term is a tolerated deviation from the point of view of the central bank and monetary policy, strong labor market and rising house prices are among other key reasons why the Bank of Canada is going to act. 

Consumer prices in Canada rose 2.1%over the year in November of 2017, following a 1.4% gain in October, the highest rate since January of 2017 with gasoline and food prices advancing at a faster pace. At the same time, core inflation that excludes volatile food and energy prices from the consumer basket also jumped up to 1.3% y/y in November, up from 0.9% y/y in October.

Canada’s inflation 2013-2017

The key argument for the Bank of Canada to act is the strength of Canada’s labor market. 

The unemployment rate in Canada fell to 5.7% in December of 2017 from 5.9% in November and well below market consensus of 6%. It is the lowest jobless rate since comparable data became available in January 1976, as the economy added 79,000 new jobs. Employment gains were concentrated in part-time work that increased 54.9 thousand) while 23.7 thousand full-time jobs were added.

Canada’s employment rise of late

With the labor market slack diminishing and the Canadian economy operating at full capacity, the case for the Bank of Canada hiking rates is justified although there are ongoing trade tensions between Canada and the USA.
Risks around a possible US withdrawal from NAFTA will likely once again be the biggest concern weighing on the Bank of Canada, but such risks are unlikely to alter the Bank’s immediate action.