July 13, 2017 / 9:29 PM / 12 days ago

Bank of Canada to hike in October as it charts slow path higher - Reuters poll

Bank of Canada Governor Stephen Poloz (R) and Senior Deputy Governor Carolyn Wilkins walk to a news conference in Ottawa, Ontario, Canada, July 12, 2017.Chris Wattie

OTTAWA/BENGALURU (Reuters) - The Bank of Canada will follow up its first interest rate hike in seven years with another increase in October as it charts a course of gradual tightening, with two more hikes expected next year, according to a Reuters poll of primary dealers.

The central bank raised rates on Wednesday, reversing some of the stimulus it added to the economy in 2015 following a plunge in the price of oil, a major export for Canada.

Nine out of the 11 institutions that deal directly with the Bank of Canada at debt auctions expect the central bank will hold steady at its next meeting in September but raise rates to 1 percent in October when it updates its economic forecasts.

Just one dealer, Casgrain & Company, forecast that the bank will move in September, while Bank of America Merrill Lynch expects the bank to hold off until January.

Economists said staying on the sidelines in September will reassure markets that the process of tightening monetary policy will be a slow one. A pause after the second hike will also allow the central bank to see how the economy is absorbing higher rates.

"The bank will want to see what the impact of that tightening is," said Josh Nye, economist at RBC, adding that the bank will also want to see evidence that low inflation is moving closer to its 2 percent target.

From there, the median forecast is for the central bank to raise rates by 25 basis points in the second quarter of 2018 and by the same amount in the fourth quarter, bringing rates to 1.50 percent by the end of next year.

"The bank would want to go for a fairly gradual pace. I don't think they would go more than once a quarter," said Nye.

Still, that is a slightly faster pace than forecast in a wider Reuters poll taken just before the bank's rate hike, which forecast rates at 1.25 percent by the end of 2018.

The rise in the Canadian dollar, which has appreciated more than 5 percent since policymakers shifted to a hawkish tone in June, is also likely to keep the bank on a slow path of hikes.

"An excessive appreciation of the Canadian dollar would not only slow inflation but also cut into export growth that the Bank of Canada is counting on for the coming year," said Avery Shenfeld, chief economist at CIBC.

One major uncertainty potentially standing in the way of hikes next year is the fate of the North American Free Trade Agreement, which is set to be renegotiated as early as next month.

While U.S. President Donald Trump said earlier this year he expected only "tweaks" to America's trade relationship with Canada, the United States has since imposed anti-dumping duties on Canadian softwood lumber.

Indeed, a Reuters poll in May found economists believe the trading arrangement may be subject to more than minor tweaks.

The United States is Canada's largest trading partner and the Bank of Canada expects the export sector to increasingly help drive economic growth this year and next.

"If the talks went really badly, it would certainly be a barrier to further rate hikes beyond this year," said Shenfeld.

The central bank is also likely to be watching the housing market, where higher borrowing costs could pinch first-time buyers and those refinancing their mortgages.

While experts have said higher rates could exacerbate a slowdown in Toronto, Canada's largest market, the housing market overall should be able to handle what are still relatively low interest rates.

"The housing market can certainly live with rates half a percent higher," said Shenfeld. "And the economy can live with a bit less contribution or no contribution from housing as other sectors kick in."

Editing by Meredith Mazzilli

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