TORONTO (Reuters) - The Canadian dollar strengthened to a one-week high against its U.S. counterpart on Wednesday after the Bank of Canada opened the door to a faster pace of tightening as it raised interest rates, as expected, for the fifth time since July 2017.
The central bank increased its key interest rate by 25 basis points to 1.75 percent and said it would continue to hike to at least 2.5 percent to keep inflation in check, while it dropped previous references to a gradual pace of tightening.
“The Canadian dollar is reacting to the removal of gradual from the Bank of Canada statement,” said Adam Button, chief currency analyst at ForexLive. “The market sees the changes in the statement as a hint that rates could rise faster.”
The central bank targeted a neutral stance for interest rates, which it estimates to be between 2.5 percent and 3.5 percent.
Money markets implied a policy rate of 2.43 percent in December 2019, up from 2.37 percent before the rate announcement.
“The biggest question mark is how are households going to react to the higher rates,” said Darcy Briggs, a Calgary-based portfolio manager at Franklin Bissett Investment Management.
Elevated levels of household debt could leave Canada’s economy more sensitive than usual to higher interest rates. Canada’s household debt-to-income ratio rose to 169.1 percent in the second quarter, near a record high.
At 2:25 p.m. (1825 GMT), the Canadian dollar CAD=D4 was trading 0.6 percent higher at 1.3009 to the greenback, or 76.87 U.S. cents. The currency touched its strongest level since Oct. 17 at 1.2969.
Gains for the loonie came even as the U.S. dollar .DXY climbed to its highest in more than two months against a basket of other major currencies.
The price of oil, one of Canada’s major exports, rebounded after several days of weakness as a much bigger-than-expected drawdown in U.S. gasoline and diesel inventories augured for a coming seasonal increase in refining demand.
U.S. crude oil futures CLc1 were up 0.7 percent at $66.90 a barrel.
Canadian government bond prices were lower across much of a flatter yield curve, with the two-year CA2YT=RR down 9 Canadian cents to yield 2.321 percent and the 10-year CA10YT=RR falling 3 Canadian cents to yield 2.453 percent.
The gap between Canada’s 2-year yield and its U.S. equivalent narrowed by 8.7 basis points to a spread of 53.0 basis points in favor of the U.S. note, its narrowest since Aug. 28.
Reporting by Fergal Smith; Editing by Bernadette Baum and Steve Orlofsky