The Bank of Canada raised its benchmark interest rate for the first time since 2007, saying inflation is unfolding as expected and that spillover from the European debt crisis has been limited, while stressing there remains "considerable uncertainty" about an "increasing uneven" global recovery.
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With his much anticipated decision to lift the central bank’s overnight rate by one-quarter of a percentage point to 0.5 percent after more than a year at a record low level, Governor Mark Carney has become the first central banker in the Group of Seven to tighten since the financial crisis and recession began in 2008.
In a statement on the move, however, Carney and his rate-setting panel sought to emphasize that investors should not necessarily interpret the increase as the first in an uninterrupted series.
"This decision still leaves considerable monetary stimulus in place, consistent with achieving the 2-percent inflation target in light of the significant excess supply in Canada, the strength of domestic spending and the uneven global recovery," the central bank said Tuesday. "Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments."
The central bank’s statement touched on themes that will no doubt be front-and-centre at the Group of 20 leaders’ meeting in Toronto at the end of June, where Canadian officials have said they will be pushing for continued efforts to smooth out the global imbalances that exacerbated the slump that much of the world is still clawing out of.
"The required rebalancing of global growth has not yet materialized," the bank said, contrasting "strong momentum" in emerging markets with recoveries in economies such as the United States and Japan that remains "heavily dependent" on low interest rates and government spending.
"In general, broad forces of household, bank, and sovereign deleveraging will add to the variability, and temper the pace, of global growth," policy makers said.
While flagging the possibility of "renewed weakness" in Europe, where drastic spending cuts and higher borrowing costs will be the likely result of continent-wide debt problems, so far the effects of the crisis on Canada have been "limited to a modest fall in commodity prices" and somewhat tighter financial conditions, the bank said.
The Canadian economy, which on Monday posted a whopping 6.1-percent annualized growth rate for the first quarter – the fastest in more than a decade – is "unfolding largely as expected," the bank said, led mostly by a hot housing market, higher incomes and a labour-market recovery that have helped fuel consumer spending.
Still, the central bank suggested that household spending and the economy will slow in the coming months as consumers deal with higher borrowing costs and try to limit or reduce their debt loads and as government stimulus spending fades. As a result, an "anticipated pickup in business investment will be important for a more balanced recovery," the bank said.
Inflation, which the central bank has been watching closely for months, has been in line with policy makers’ projections to exceed 2 percent this year and reflects a combination of strong domestic demand, slowing wage increases and "excess supply" leftover from the recession.
The central bank also said it is making a technical, yet significant, change to re-establish "normal functioning" of the overnight market, whereby its benchmark will return to halfway between the rate it pays to chartered banks to hold deposits and the amount that it charges private-sector lenders for loans.
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