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Bank of Canada expected to raise key interest rate Wednesday

The Bank of Canada is widely expected to boost a key interest rate on Wednesday as it resumes efforts to "wean" the economy off low borrowing costs.

The bank's target for the overnight rate — what major financial institutions charge each other for one-day loans — has been at 1.25 per cent since mid-January. Since then, the bank has stood firm on three subsequent rate announcements.

That string is generally expected to end this week. As of Tuesday, the implied probability of a rate hike to 1.5 per cent stood at just over 96 per cent, according to Bloomberg.

A hike could lead financial institutions to raise prime rates, and see Canadians pay higher borrowing costs on such products as variable-rate mortgages.

The pending rate announcement comes against a backdrop of somewhat cooler economic growth, gains in employment and inflation running roughly on the Bank of Canada's two per cent target.

"Given that the economy is pretty average at this point, I think that does clear the decks for the bank to slowly but surely get interest rates back to what they would consider to be average or normal." said BMO Capital Markets chief economist Douglas Porter.

"So we're expecting the Bank of Canada to raise interest rates this week."

CIBC is also expecting a hike, which it believes will be the last for this year.

"In Canada, economic news has generally improved for [the second quarter], and although that's likely enough to prompt a quarter point hike in rates on Wednesday, it's not as if the evidence of overheating is so overwhelming," said CIBC Capital Markets chief economist Avery Shenfeld in a recent commentary.

No 'comfortable transition'

The Bank of Canada wants to, and needs to, "normalize" interest rates, said Frances Donald, senior economist with Manulife Asset Management.

 "We need to wean ourselves off of those super-low interest rates and toward the more normal interest rate environment," she said. "That's not a comfortable transition for any economy, but for our longer-run economic health, it's necessary."

However, not all forecasters believe Bank of Canada governor Stephen Poloz will tighten monetary policy this week.

In a recent commentary, economists at National Bank said deterioration of the international trade outlook since the last rate decision "ought to give pause" to the Bank of Canada.

"Indeed, with the U.S. threatening to instigate a trade war with China, and with NAFTA negotiations stalling, we don't see conditions as supportive of further monetary policy normalization," they said. "Consequently, we expect the central bank to remain on the sideline this week, an opinion that runs counter to the market's view."

Outlook update

Wednesday's rate announcement will also be accompanied by a quarterly update to the bank's outlook for the economy, but several economists said they don't expect the central bank will alter its forecasts.

"We're not expecting major changes in the growth outlook overall, with the bank not going to take a guess on trade barriers that have yet to be announced," said CIBC's Shenfeld.

Assuming that rates do rise this week, Porter said to watch for any indications the bank will move to the sidelines for a while and see what happens on the trade front, or if it will continue "grinding away" with gradual tightening.

The Bank of Canada has three more rate announcements set for this year: Sept. 5, Oct. 24 and Dec. 5.

Scotiabank said it remains more hawkish on future interest rates than the street, as it is forecasting three rate increases over the next six meetings through the first quarter of 2019 — about one more than the markets are expecting.

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