3 reasons the interest rate hike is good for the Trudeau Liberals

The Bank of Canada rate increase is a sign of confidence in the Canadian economy, giving the federal government ammunition for the argument that its fiscal plan, including deficit spending, is working.

1st increase in 7 years a sign economy is turning around

Following an interest rate hike from the central bank, Canada's five biggest banks all announced they are increasing their prime rates to 2.95 per cent from 2.7 per cent, effective Thursday. (Nathan Denette/Canadian Press)

The Bank of Canada's first interest rate hike in seven years has many implications, but Canadians are likely focusing on what it means for their mortgages and other borrowing.

While it's a relatively small increase of only one-quarter of a percentage point, from a political standpoint it helps the Liberal government argue that its fiscal plan to turn the economy around is working.

"The move to hike the interest rate shows confidence that the improving economy is here to stay," said RBC chief economist Craig Wright in an interview with CBC News. Such a small increase has few downsides, he said. "The majority of Canadians will not be harmed by this move."​

1. It's a sign of a strengthening economy

The Trudeau government has been criticized for deficit spending with no plan to return to a balanced budget. Its response has been that it is making key investments to grow the economy. Almost two years into the government's mandate, the first interest rate increase in seven years is a sign things are finally turning around.

"This is good news for Canada," said Stephen Poloz, governor of the Bank of Canada, in a news conference Wednesday.

"The accumulation of evidence, and the growth in our confidence that the economy is on a solid trajectory, should be good news for everybody. I know not everyone will think a higher interest rate is good news, but it is a symptom of an improving economy. And interest rates are still very low," he said. 

Bank of Canada governor Stephen Poloz says the Trudeau government's Canada child benefit has boosted consumer spending. (Justin Tang/Canadian Press)

Poloz pointed at the Trudeau government's Canada child benefit as a reason behind the healthy growth in consumer spending and said that the Bank of Canada's economic modelling took into account the upcoming influx of money into infrastructure spending planned by the Liberal government.

The Bank of Canada's monetary report also said that the economic growth is not limited to one or two sectors or regions, but is broadening across the country.

2. Concern over uncertainty in the U.S. is being managed

Poloz said that part of the reason his outlook is more positive than expected is that the Bank of Canada has pushed concerns about the uncertainty of U.S. fiscal policy to the background, as it appears business leaders have done so themselves.

Business investment is improving. That, said Poloz, is an indication businesses are no longer waiting to see if a Trump administration moves on its promises to slash taxes, bring in a border tax and spend big on infrastructure.

While there is still uncertainty surrounding the U.S. economy and the future of NAFTA since Donald Trump came to office, businesses appear to be taking it in stride. (Sean Kilpatrick/Canadian Press)

"That uncertainty remains," he said. "Investment in Canada is less today than it would be without that uncertainty, but people seem to be setting it aside and sort of getting on with things, so we are seeing a recovery, stronger investment."

Of course, some businesses that depend heavily on what happens with NAFTA might still be holding back as negotiations loom.

But both the current government and its predecessor grappled with businesses sitting on their wallets, blaming some of Canada's economic under-performance on that tight-fisted caution.

It's good news for the Liberal government if Canadian businesses are not being held back by the uncertainty about  the Trump administration's trade, tax and investment policies.

3. Lower oil prices have been absorbed by the economy

Adjustments are still being made in the oil sector, and there remain unemployed workers and people who have had to take lower-paid jobs. But the shock of the energy sector contraction is "in the rear-view mirror," said Poloz.

"That appears to be complete. Companies can go on … obviously they would prefer a higher oil price to a lower oil price, but the $40 to $60 zone in which we've been in for quite a while now, that's kind of become the norm and people have adjusted to that lower price."

The Canadian economy has largely weathered the shock of lower oil prices. (Jeff McIntosh/Canadian Press)

That's another good sign for the government, according to the RBC chief economist.

"The gap between the strongest and weakest provincial economies has narrowed," Wright said. In other words, while Alberta still suffers, it is coming out of the depths of the downturn.

Canada's ability to absorb and adjust to the new normal of lower oil prices means more stability in the economy and more predictable outlooks, making fiscal planning easier for the government.