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The Bank of Canada (BoC) has become the second advanced-economy central bank to raise rates during the current cycle. The move follows four US Federal Reserve rate hikes. In 2010, the BoC raised its rates following similar moves by the ECB and the Swedish Riksbank, only to drop them again to soften the impact of collapsing oil prices on the Canadian economy. The recent move takes Canada’s key policy rate from 0.50% to 0.75%.
The decision confirms that central banks are gradually shifting towards tighter monetary policy in advanced economies, barring a few exceptions such as the Bank of Japan. Although Canada’s underlying inflation rate remained weak in May at 1.3%, growth is healthy, reaching 3.3% in April. Unemployment is falling and, at 6.5%, is close to its 2007 record low.
The statement suggests that the BoC is being guided by traditional monetary policy. It believes that recent softness in inflation is temporary and that traditional economic models such as the Phillips curve, where falling unemployment leads to higher inflation, remain in play and will shape the quarters ahead. Given the long lag between monetary policy action and its effects on the economy, the central bank prefers to act early. However, how far rates should go remains unknown, especially since high household debt levels have raised interest rate sensitivity.
The opinion expressed above is dated 19 July 2017, and is liable to change.
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