Bank of Canada Ploughs Ahead With 0.25% Interest Rates Increase

The Bank of Canada has just announced that it’s increasing the target for the overnight rate, it’s key interest rate, for the third straight time by 0.25% to bring it up to 1%. This means that mortgage lenders will also increase their Prime rates by the same 0.25% to 3.00%, resulting in variable mortgage rates also increasing by 0.25% as well.

This Bank of Canada rate increase follows the same 0.25% hikes on June 1 and July 20th and comes as the Federal bank wants to remove the exceptional fiscal stimulus that was put in place to fend off the global economic crisis. Right up to the rate announcement this morning, the market was split on whether Bank of Canada Governor Mark Carney would actually continue increasing rates after recent poor economic results showing slowing growth in US and Canada. Also, the latest inflation report showed that inflation was below the Bank’s 2% target, which was another reason that many thought the Federal Bank would hold off increasing rates.

You can view a summary of the Bank of Canada’s rate announcement results this year here.

Our Mortgage Rate Outlook Panel thought rates wouldn’t be increased due to the recent economic data that was published. It seems that the need to return to a ‘normal’ interest rate environment, the average Prime rate for the past 10 years is 4.79% versus 3.00% after this morning’s announcement, took precedent over the threat of halting Canada’s slowing economic growth, and the fact that inflation seems to be under control with no immediate risk of getting out of hand in the near future.

The Bank of Canada cited the following reasons for their move:

Around the world

  • The global economic recovery is proceeding but remains uneven
  • The US recovery in private demand is being held back by high unemployment and an expected slower recovery in the near term

At home

  • Economic activity in Canada was slightly softer in the second quarter than the Bank had expected
  • Consumption and investment have evolved largely as anticipated
  • Consumption growth is expected to remain solid and business investment to rise strongly as they are being supported by accommodative credit conditions, which have eased in recent weeks mainly owing to sharp declines in global bond yields.
  • Economic recovery in Canada is expected to be slightly more gradual than it had projected in its July Monetary Policy Report (MPR), largely reflecting a weaker profile for U.S. activity.
  • Inflation in Canada has been broadly in line with the Bank’s expectations and its dynamics are essentially unchanged.

They went on to say that over the past few months as the Bank has started removing monetary policy stimulus (ie. started increasing interest rates from all time lows, which was needed to battle through the global economic crisis), financial conditions have deteriorated slightly, but the economy is still moving ahead with the help of these exceptionally low rates. Even though inflation is within target the Bank wants to return to a ‘normal’ rate environment and let the private sector lead Canada back to strong economic growth.

They ended the announcement by saying that any further increase in interest rates will need to be considered very carefully due to the uncertainty of both the global and national economic recovery. Many expect they will now pause, review the impact of these hikes for the rest of the year and then revisit increasing rates in 2011.

This was the big question, as Governor Carney does not want to keep increasing rates and effectively put the brakes on growth and send us back into a recession rather than treading that fine line and hike rates, keep inflation at or under 2% while the economy keeps growing. That’s a very tough job, and hard to do. We’ll see how this turns out.

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