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Bank of Canada hikes key interest rate to 1.25%

18 January 2018

Royal Bank of Canada and BMO Bank of Montreal were first among Canada's banks to respond to the rate hike, raising their prime lending rate by a quarter of a percentage point, to 3.45 per cent, effective Thursday.

"Today's rate hike was a rear-view mirror move, but the Bank of Canada hints that the view out the front window isn't quite as sunny".

But the "balanced tone" of a news conference with Bank of Canada Governor Stephen Poloz and Senior Deputy Governor Carolyn Wilkins helped the currency recover, said Eric Theoret, currency strategist at Scotiabank. However, it cautions about the substantial improbability linked to the possible changes of policy by the USA, which is its major dealing partner.

On Wednesday, the bank couldn't ignore the data even as it acknowledged that the heightened uncertainty surrounding the future of the North American Free Trade Agreement - and the potential negatives for Canada - was casting a shadow over its outlook. The bank increased its rates in July and September in 2017.

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But, Wednesday's hike, might not translate to a more aggressive central bank this year, according to analysts.

The promise by Trump to have the policy amended together with his patriot vow which would cost export and Canadian investment.

"Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity", the bank said in a statement. The bank estimates that trade uncertainty will cut business investment over the next two years by two percent.

The Monetary Policy Report assessed the key risks to the economic outlook.

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The Canadian dollar weakened modestly after the hike as investors realized that markets may have gone too far in pricing in more or faster rate hikes than the bank is contemplating.

The central bank says consumption and residential investment have been stronger than anticipated, reflecting strong employment growth.

But while global commodity prices continue to grow, the benefits to Canada are being diluted by wider spreads between benchmark world and Canadian oil prices, the bank said. Prior to the Bank of Canada's move, their rates were all 3.2 per cent.

The decision was widely expected, as market odds projecting a rate hike were close to 90% prior to the announcement. Also, the BoC expects the economy to expand 1.6 percent in 2019.

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Economist Frances Donald with Manulife agrees with that assessment, telling CBC News in an interview that while the market was expecting as many as three hikes this year, the situation is fluid. TD Economics expected a gradual pace of tightening over the next two years of about 25 basis points every six months.

Bank of Canada hikes key interest rate to 1.25%