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Canada joins U.S. in hiking interest rate, with caution

Bloomberg OTTAWA (Bloomberg) — Canada cautiously became the first Group of Seven country to join the United States in raising interest rates on Wednesday, feeding speculation the world’s central bankers are entering a tightening cycle.

The central bank raised its benchmark rate to 0.75 percent from 0.5 percent, while adding an element of prudence by warning future rate hikes will be “guided” by the data.

Investors are looking at the decision as a possible harbinger of things to come globally and are monitoring it for clues on the central banks’ resolve for withdrawing stimulus, with the prospect of tightening triggering a selloff in government bond markets over the last two weeks. Canadian government bond yields and the country’s currency rose after the hike, on expectations the Bank of Canada will follow with a second increase this year.

“Monetary policy is not on a predetermined path,” Governor Stephen Poloz said in opening remarks ahead of a press conference in Ottawa. Later, he said he didn’t doubt that interest rates would be higher over time. “It will remain highly data-dependent as we move forward,” Poloz said.

Canada is in the midst of one of its strongest growth spurts since the 2008-09 recession, with the expansion accelerating to an above-3 percent pace over the past four quarters. That’s the fastest among G-7 countries and double what the central bank considers Canada’s capacity to grow without fueling inflation.

The acceleration in growth, and its broadening to more sectors and regions, has increased “confidence” the economy will continue to absorb excess capacity, the Bank of Canada said. The central bank estimated the economy will return to full capacity by the end of 2017.

“Governing Council judges that the current outlook warrants today’s withdrawal of some of the monetary policy stimulus in the economy. Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities,” the bank said in its statement.

The stronger economy also means policy makers can finally begin the process of weaning the nation from cheap credit that has driven home prices to unaffordable levels, left the nation’s households with record debt and exposed Canada to a financial crisis.

Market reaction

How quickly Poloz normalizes rates is still an open question. Markets have about fully priced in a second rate hike by December, which would fully reverse the two cuts Poloz made in 2015 to counter the effects of falling oil prices, according to Mark Chandler, head of fixed income research at Royal Bank of Canada. A third rate hike is priced in by the end of 2018.

The Canadian dollar jumped 1.6 percent, to its highest level in a year. Two-year Canadian government bonds jumped 7 basis points to 1.19 percent, the highest since November 2013.

“The market took it hawkishly both in terms of rates and the currency,” Chandler said.

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