Bank of Canada holds key interest rate steady, but next rate hike likely not far off

As expected, on Wednesday the Bank of Canada announced it was holding its key monetary policy interest rate at 1.25%, however the statement released with the decision seemed to indicate that the next rate hike could be on the horizon, according to TD Economics.

"No surprise here," Brian DePratto, TD Senior Economist wrote in a note to clients and customers on Wednesday morning.

"With the economy set to outperform the Bank's earlier expectations and signs of life in all sectors bar housing, economic conditions favour another interest rate hike. While we may need a grammarian to distinguish between "cautious" and "gradual," the message was nevertheless clear: get ready for another rate hike."

The Bank of Canada announced it would be maintaining its target for the overnight rate – the interest rate at which major financial institutions borrow and lend one-day funds among themselves – with global economic activity remaining positive and despite uncertainty about trade policies dampening international business investment.

In its analysis of the decision, TD Economics said economic developments since April are seen as in line with the Bank of Canada's view, albeit for the first half overall, given an expected Q1 outperformance. Housing activity is expected to improve as the year continues, helped by rising incomes. The Bank of Canada sees consumption continuing to play an important role, suggesting that household finances are not (in their estimation) particularly pinched by recent rate hikes.  

Beyond Canadian borders, some upside is seen for the U.S., but trade policy uncertainty remains a dampening factor. Emerging market stresses were also highlighted, while recent oil price moves were characterized as driven by geopolitical developments.  

On the inflation front, DePratto said there is little to get excited about.

"The Bank of Canada expects inflation to exceed its earlier forecasts due to gasoline prices, but reminded us that, as usual, they will look through this transitory factor."

Still, the positives outweigh the negatives in the Bank of Canada announcement, DePratto said.

"Indeed, perhaps the most explicit signal was the dropping of the qualifier 'over time' in regards to higher rates, and the only reference to labour markets was expectations for 'solid' income growth – gone are concerns about potential slack," DePratto said.

"This reinforces our view that as the economy continues to perform well into the middle of the year, the Bank will have the confidence it needs to raise its policy interest rate at its next scheduled decision, this July."