Question 19N.2.SL.TZ0.2c

Bank of Canada raises interest rates for the first time in seven years

1. For seven years Canada’s central bank, the Bank of Canada, kept its official interest rate at 0.5 %. This period of easy monetary policy may be coming to an end. The Bank of Canada has just raised its official interest rate from 0.5 % to 0.75 %, claiming that there is new confidence in the Canadian economy. Figures show that the 3.5 % growth in gross domestic product (GDP) in the first quarter of 2017 is above its potential. In addition, the Bank of Canada expects growth in consumer spending, exports and business investment to stimulate economic growth in the months ahead. Such factors might contribute to inflationary pressure in the future.
   
   
2. One of the issues that might have delayed the interest rate increase in Canada is that the inflation rate is still low and falling. Central banks typically raise interest rates when inflation is rising. That is not the problem in Canada, where the consumer price index (CPI) has been rising at well below the Bank of Canada’s 2 % inflation target. However, the governor of the Bank of Canada says that he is looking at forecasts of future inflation rates, noting that the data suggest the interest rate increase is necessary. An official statement from the Bank of Canada notes that growth is increasing across all industries and regions and that the economy has started to improve. There is no longer a need for the low interest rate.
   
   
3. Positive economic growth figures, the optimism shown by the Bank of Canada, and the recent interest rate increase have caused a rapid appreciation of the Canadian dollar against the United States (US) dollar over recent months. There are now expectations that the Bank of Canada will raise the interest rate once or possibly twice more before the end of the year, as signs continue to point to a healthy economy. This would likely cause further strengthening of the Canadian dollar against the US dollar.
   
   
4. An economist has said that the gain in the Canadian dollar against the US dollar may have a large effect on importers and exporters, although it will likely be months before consumers see the effects. She further noted that the effects would vary across different industries. There is some concern about the consequences for the Canadian current account. Currently the current account deficit is at 3.6 % of GDP.
   
   
5. A stronger currency is also likely to encourage more Canadians to travel south to the US.

[Source: adapted from Bank of Canada raises interest rates for first time in seven years,
The Globe and Mail, July 12, 2017, https://beta.theglobeandmail.com]

Table 1: Canada’s main exports

[Source: adapted from https://tradingeconomics.com, accessed 4 September 2017]

Table 2: Canada’s main export destinations

[Source: adapted from https://tradingeconomics.com, accessed 5 October 2017]