September 1, 2017 / 2:11 PM / a year ago

Chance of a Bank of Canada rate hike next week becomes a coin toss

TORONTO (Reuters) - Chances of a Bank of Canada interest rate hike next week rose on Friday to 50-50, the overnight index swaps market indicated, while data showing rapid economic growth in Canada lifted the country’s 2-year yield above its U.S. equivalent for the first time in two years.

A sign is pictured outside the Bank of Canada building in Ottawa, Ontario, Canada, May 23, 2017. REUTERS/Chris Wattie

The Bank of Canada raised rates in July for the first time in nearly seven years, the only major central bank other than the U.S. Federal Reserve to have hiked this year. Its policy rate sits at 0.75 percent.

Canada’s economy grew at an annualized 4.5 percent in the second quarter, its fastest pace in nearly six years.

The market is weighing what the strength of the data “might imply for the Bank (of Canada) next week,” said Mark Chandler, head of Canadian fixed income and currency strategy at RBC Capital Markets.

With Canada’s inflation rate stuck well below the Bank of Canada’s 2 percent target, markets had anticipated that the central bank would wait until October before raising rates again. But chances of a hike as soon as next week have climbed to nearly 50 percent from around 20 percent before Thursday’s GDP report, data from the overnight index swaps market showed. BOCWATCH

Investors have nearly fully priced in a rate hike by October.

The Canadian dollar jumped to a 2-year high against the greenback as Canada’s 2-year yield climbed above its U.S. equivalent for the first time since May 2015, with the spread shifting 5.5 basis points on Friday to slightly above parity.

The shift in spread came even as U.S. Treasury yields rose, boosted by data showing U.S. job growth at a pace that should be more than sufficient for the Federal Reserve to announce a plan to start trimming its massive bond portfolio.

Still, anemic wage gain could make the U.S. central bank cautious about raising interest rates again this year, with money markets pricing in less tightening from the Fed over the coming months than from the Bank of Canada.

“The Bank (of Canada) is in the process of removing accommodation,” Chandler said. “Yields are still lower than what we would expect, if not for inflation, but certainly for growth.”

A stronger currency and higher bond yields have tightened financial conditions somewhat, but not enough to derail growth in Canada’s economy, he added.

Reporting by Fergal Smith; Editing by Chizu Nomiyama and David Gregorio

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