Loonie shoots higher as Bank of Canada hints at future rate hikes

Canada's central bank decided Wednesday to hold the line on a key interest rate, leaving its target for the overnight rate steady at 1.25% and driving up the loonie.

Next rate decision comes on July 11

Bank of Canada governor Stephen Poloz and other senior leaders believe higher interest rates will be needed in the future to keep inflation near the central bank's s target of two per cent. (Fred Chartrand/Canadian Press)

The Canadian dollar shot up Wednesday after the Bank of Canada held the line on a key interest rate but pointed to a boost in the future. 

In foreign exchange trading, the loonie was ahead by 0.82 of a cent at 77.64 cents US when stock markets closed on Wednesday, after being up by more than one cent earlier in the day. 

The central bank left its key target for the overnight rate unchanged at 1.25 per cent, where it has been since mid-January.

However, the bank said in a statement accompanying its decision that developments since April reinforce its view that "higher interest rates will be warranted to keep inflation near target."

The bank said Canadian inflation has been running close to its two per cent target lately, and will likely go higher due to a recent rise in gasoline prices.

The bank also said current Canadian economic data backs its forecast for two per cent growth over the first half of this year.

The Bank of Canada's next interest rate decision is slated for July 11. On that date, it will also provide an update to its economic outlook.

According to Bloomberg, the implied probability of a July 11 rate boost is now 79.5 per cent. On Tuesday, those implied odds were 53.2 per cent.

"No surprise here," TD senior economist Brian DePratto said in a commentary.

"With the economy set to outperform the bank's earlier expectations … and signs of life in all sectors bar housing, economic conditions favour another interest rate hike," he wrote.

Economists also noted that the central bank dropped some of the more cautious wording it had been using in statements about the likelihood of future rate increases.

"The statement was much more hawkish than the market anticipated, especially after the early week global financial market gyrations," BMO economist Benjamin Reitzes said.

"This is a clear warning shot that a July rate hike is solid possibility," he said.

The rate decision came a day before Statistics Canada is due to release its latest report on the state of the Canadian economy.

"First quarter real GDP data are released tomorrow and will provide another glimpse into the economy and if it is operating as the [Bank of Canada] projects, and ultimately help to determine the timing of the next rate hike," Arlene Kish, IHS Markit director for Canadian economics, said in a commentary.

The overnight rate is what major financial institutions borrow and lend at for one-day funds among themselves. Movements in the Bank of Canada's target for the overnight rate influence other interest rates, such as those for consumer loans and variable-rate mortgages.

At this time last year, the target for the overnight rate stood at a record low 0.5 per cent, but since then, the Bank of Canada has embarked on a course of gradual tightening of monetary policy, boosting the rate three times by one-quarter of a percentage point each time.