[Moody's Analytics] The Bank of Canada's Expected Rate Hike and Impact

by Yvonne von Jena | July 9, 2017

Moody's Analytics is expecting the Bank of Canada to raise its benchmark interest rate twice in 2017, with the first anticipated this week at the Bank’s monetary policy meeting resulting in a rate of 0.75%, up from 0.5%. If it does happen, this will be the first rate hike made by the Bank since September 2010.

Why the Hike Is Expected

An encouraging string of data has come out in recent weeks that supports the expectation of higher rates. Here are a few highlighted by Moody’s Analytics:

  • Exports are up 18% from a year ago due to broad-based gains in almost every industry
  • The value of building permits increased in May by almost 11% on a year-ago basis, with gains in both residential and nonresidential contributing
  • The Ivey Purchasing Managers' Index grew to 61.6 in June, which is the 13th straight month in which more firms reported higher sales than in the prior month, echoing the positive sentiment from the Bank of Canada's Business Outlook Survey
  • The labor force survey reported another large monthly job gain, with total employment up by 45,000 in June and the unemployment rate down 0.1 percentage point to 6.5%

Monetary policymakers have signaled a more hawkish stance in recent weeks, and the latest employment figures should remove any remaining hesitance to act.

The Expected Impact

There are risks to keeping interest rates low, but hiking will also cause pain. Here are the most notable risks of higher interest rates per Moody’s Analytics:

  • Disproportionate impact provinces, as economic growth is far from uniform across Canada
    • The jobless rates in British Columbia, Ontario and Quebec are testing new post-recession lows, but
    • Unemployment in Alberta and Saskatchewan remains stubbornly high relative to historical averages
  • Households will find it harder to handle increased debt payments
    • Although higher rates will help slow house price appreciation, the major cause of concern will be how households react to higher borrowing costs
    • Canadian households have high and rising debt-to-income ratio, so rate hikes could increase the risk that households will not be able to manage the higher payments on debt (leading to higher defaults and collapse in household spending that would have harsh consequences for the macroeconomy), however
    • The labor market is likely to maintain upward momentum for the rest of the year, wage pressures will pick up as the supply of available workers becomes more limited; an acceleration in income growth should ensure that household debt loads remain manageable

Should the labour market not maintain this upward momentum and coupled with the current downturn in energy from low oil prices, a rise in defaults and pullback in consumer spending would be the catalyst for Canada's next recession says Moody’s Analytics.