Bank of Canada Raises Benchmark Rate, Warns on Nafta Risk

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"We had thought that the stagnation of the economy net-net since the two rate hikes in Q3 (judging from the monthly GDP readings), signs of softness in house prices in Toronto and Vancouver areas, coupled with the strength of the Canadian dollar and NAFTA uncertainties would have removed any sense of urgency from the central bank", analysts at BBH wrote in a note to clients.

The central bank pointed to unexpectedly solid economic numbers as key drivers behind its decision to hike the rate to 1.25 per cent, up from one per cent.

That came after regulators worldwide began accusing, and eventually fined, many banks for manipulating the London Interbank Offered Rate and other benchmarks.

Poloz, speaking in a news conference in Ottawa on Wednesday, said the North American Free Trade Agreement "channel" he's most focused on is the impact on business investment.

The claim alleges the banks manipulated the Canadian dealer offered rate - which reflects what rate contributors are willing to lend to corporate clients using an instrument called a bankers' acceptance - from at least August 9, 2007, to June 30, 2014. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade. This could steady out the mortgage markets as home buyers get used to the new higher rates and stringent rules.

The central bank said while higher interest rates would be justified "over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target" close to two percent.

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At 2:46 p.m. EST (1946 GMT), the Canadian dollar was trading 0.4 percent higher at C$1.2387 to the greenback, or 80.73 US cents.

The bank's benchmark rate is now at its highest level since 2009. What's more, despite the positive run of labour market data, wage growth remains weaker than the Bank had expected.

The bank expects inflation to remain around 2 per cent in the months ahead. It expects the economy to expand by 1.6 per cent in 2019, up from its previous call of 1.5 per cent.

The trade uncertainty is expected to reduce the level of investment by about 2 percent by the end of 2019, the bank said in its Monetary Policy Report.

The gap between the two-year yield and its US counterpart widened by 2.9 basis points to a spread of -27.4 basis points, its widest since December 15.

Although Canadian's competitiveness would be affected, the bank is having their base-case point of view reasoned by the impact of the likely increase of the US economy that will increase demand which can aid Canada and the impact of Trump's move to have corporate taxes put to an end.

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