After a summer of surprisingly good economic news, the Bank of Canada raised its benchmark interest rate a quarter of a percentage point to 1 per cent Wednesday – its second rate hike in less than two months and a prelude to higher borrowing costs for Canadians.
Major lenders, including Royal Bank of Canada, responded by raising their own prime lending rates by the same amount – moves that could squeeze the most heavily indebted Canadians and discourage others from buying homes.
The earlier-than-expected move caught investors and analysts off-guard, sending the Canadian dollar up to nearly 82 cents (U.S.) and raising expectations of more hikes this year. The dollar is now up about 14 per cent since hitting a low for the year of roughly 73 cents in April.
Bank of Canada Governor Stephen Poloz and his central bank colleagues acknowledged they have been taken aback at the strength of the economy, which surged ahead at an annual pace of 4.5 per cent in the second quarter to lead the Group of Seven countries. As recently as July, the central bank said GDP growth would reach just 2.5 per cent in the second quarter.
Wednesday's rate decision reinforces the message that the era of easy money and low rates is coming to an end in Canada. The central bank's overnight rate generally sets the pattern for mortgages, bonds and deposits.
The Bank of Canada may not be done. Economists are already bracing for further hikes if the economy continues to show strength through the rest of the year.
"Absent a significant shock, [Wednesday's] rate increase will be part of a larger and longer march towards rate normalization," Toronto-Dominion Bank economist Brian DePratto said in a research note.
Bank of Nova Scotia economist Derek Holt applauded the central bank for doing "the right thing" and said the door is "wide open to further rate hikes."
But there are limits on how far and fast the Bank of Canada can get its benchmark rate back to a more normal level.