As the market had widely anticipated, BOC has increased the overnight rate target, for the first time in 7 years, to 0.75%, from the historical low of 0.5%. The Bank Rate and the deposit rate rose to 1% and 0.5% respectively. Policymakers acknowledged the improvement in macroeconomic data, noting that the central bank's confidence in its outlook for above-potential growth and the absorption of excess capacity in the economy had been improved. Although inflation has remained soft, BOC judged that it is temporary and would reach the target by the middle of 2018.
Canadian GDP expanded +3.7% q/q in 1Q17, accelerating from +2.6% a quarter ago. BOC forecast real would expand to +2.8% this year, +2% in 2018 and +1.6% in 2019. The Bank estimates real GDP growth will moderate further over the projection horizon, from 2.8 per cent in 2017 to 2.0 per cent in 2018 and 1.6 per cent in 2019. On inflation, BOC noted that it has "eased in recent months" and its three measures of core inflation all remained below +2%. Policymakers attributed the weakness to "heightened food price competition, electricity rebates in Ontario, and changes in automobile pricing". They believed these factors would only temporarily affect the general price levels. BOC expects inflation to return to about +3% by mid-2018, as "the effects of these relative price movements fade and excess capacity is absorbed".
The employment market has also improved of late. Released last Friday, the June employment report shows that the number of payrolls increased +45K, lowering the unemployment rate to 6.5%. Yet, most of the addition was part-time jobs (up +37K). In the accompanying report, BOC suggested that, given the fact that participation rate in Canada does not decline as much as that in the US, the "scope for drawing more prime-age workers in the Canadian labour force is more limited than it is in the United States".
On the monetary policy outlook, BOC affirmed that "future adjustments to the target for the overnight rate will be guided by incoming data as they inform the Bank's inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities". We expect today's rate hike marks the beginning of BOC's monetary normalization path, though any further increase would be gradual and data-dependent.