Bank of Canada hikes rates, takes dovish tone amid NAFTA clouds

Bank of Canada Governor Stephen Poloz takes part in a news conference in Ottawa, Ontario, Canada, January 17, 2018. REUTERS/Chris Wattie

OTTAWA (Reuters) - The Bank of Canada raised interest rates on Wednesday, as expected, as job growth and firmer inflation outweighed the cloud of NAFTA uncertainty, but the head of the central bank admitted the decision was not a no-brainer.

In sounding a cautious tone on the future of the North American Free Trade Agreement as it raised rates for the third time in seven months, taking borrowing costs to their highest level since 2009, the bank accomplished the so-called dovish hike that many analysts had predicted.

“We didn’t walk into this as if it was a no-brainer, that it was time to move rates. There was a good debate around that. It’s not that we were arguing but we were debating the pros and cons ... the big cloud over the forecast, as well as our discussion, is NAFTA,” Governor Stephen Poloz told a news conference.

While more rate hikes are probably warranted, some continued monetary policy accommodation will likely be needed to maintain optimal growth and inflation, the bank said, signaling it will not rush to return rates to more normal levels after they were slashed to historic lows in the wake of the financial crisis.

The future of NAFTA, which U.S. President Donald Trump has threatened to terminate, was the most significant downside risk cited by the bank in an otherwise bullish report on the outlook for Canada’s economic growth.

The Canadian dollar weakened modestly after the hike as investors realized that markets may have gone too far in pricing in more or faster rate hikes than the bank is contemplating.

“It seems the Bank of Canada is leaning towards a more dovish stance and certainly playing up the concerns around NAFTA. That should pose some questions to all those rate hikes priced into the market,” said Adam Cole, chief currency strategist at RBC Capital Markets in London.

The hike acknowledges that recent data has come in stronger than the bank had expected, inflation is close to the bank’s 2 percent target, and the economy is now operating at full potential with no output gap.

The bank said that trade uncertainty is expected to cut investment by about 2 percent by the end of 2019, while U.S. tax reforms will trim another 0.5 percent as firms may decide to redirect spending from Canada to the United States to benefit from lower corporate taxes.

Additional reporting by Fergal Smith in Toronto and Saikat Chatterjee in London; Editing by Bernadette Baum and Phil Berlowitz