December 15, 2017 / 8:59 PM / 3 months ago

Bank of Canada sticks with rate hike bias despite NAFTA uncertainty

TORONTO (Reuters) - The Bank of Canada is leaving the door open to further interest rate hikes in early 2018, making it clear that a number of uncertainties that could derail the economy, such as NAFTA renegotiation, are a reason for caution but not inaction.

Bank of Canada Governor Stephen Poloz gestures as he speaks during a news conference in Ottawa, Ontario, Canada, October 25, 2017. REUTERS/Chris Wattie

Investors worry that terminating the North American Free Trade Agreement (NAFTA) could hurt Canada’s economy and pressure its currency and a survey released on Friday by the nation’s export credit agency underscored those concerns.

Canada sends 75 percent of all goods exports to the United States and could be badly hit if Washington walks away from NAFTA, which Trump has blamed for American job losses and big trade deficits for his country.

The survey showed around 6 percent of Canadian firms could move part of their operations to the U.S. as a way to cushion the potential blow.

But waiting for uncertainties, such as NAFTA renegotiation, to clear before raising rates again could add to imbalances in Canada’s economy, which has been boosted this year by a once red-hot housing market and the growing indebtedness of Canadians.

“If you’re going to go home from work and there’s a snow storm that afternoon, you may drive more cautiously ... That doesn’t, I don’t think, translate into sitting in your car in the parking garage until the next day and going back to work,” said Bank of Canada Governor Stephen Poloz in a press conference after a speech on Thursday.

Chances of a rate hike in January have increased to 36 percent from 30 percent before Poloz’s speech, the overnight index swaps market indicated.

The loonie, as the Canadian currency is called, rallied as much as 1.1 percent after the speech but has since given up those gains.

Other uncertainties that concern the Bank of Canada include tighter mortgage rules that come into effect in January, and how the economy will respond to the two rate hikes earlier this year, which took the benchmark interest rate to 1 percent.

The central bank estimates Canada’s economy is operating close to potential.

“Monetary policy is way too loose given where we are in the economic cycle,” said Krishen Rangasamy, senior economist at National Bank Financial. “Instead of focusing on what may or may not happen with NAFTA, they should focus on what is happening, which is debt accumulation and household imbalances getting worse.”

Canadian household debt as a share of income reached a record high of 171.1 percent in the third quarter, data showed on Thursday.

It suggests “recent rate hikes have done little to cool household credit demand,” Robert Both, macro strategist at TD Securities, said in a research note.

He also questions whether there is slack left in the labor market. Perceived labor market slack is one of the reasons why the central bank has held off from hiking further since September.

“Poloz clearly has some worries, but the bias is towards hiking, and it’s only a matter of time until it comes,” said Adam Button, currency analyst at ForexLive.

Reporting by Fergal Smith; Editing by Susan Thomas

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