Bank of Canada expected to keep rates on hold, but reasons for a hike 'solid'

The Bank of Canada is widely expected to keep interest rates on hold in its monetary policy decision on Wednesday, with many expecting the central bank to sit on the sidelines a bit longer as trade negotiations between Canada and the U.S. continue.

The odds of an interest rate hike tomorrow are below 10 per cent, according to trading in investments known as overnight index swaps. But, those odds jump to more than 80 per cent for a rate hike next month.

While many economists think that last week's second quarter GDP miss may be enough for the central bank to stand pat for now — after hiking rates for the fourth time in a year in July — not all are convinced that they should wait. 

Derek Holt, head of capital market economics at Scotiabank, said the Bank of Canada has plenty of reasons for a hike this time around.

"Our longstanding house call for a hike tomorrow is admittedly marked by modest conviction, but there, nevertheless, remains a very solid case for continuing to hike and the risk of surprise should be higher than markets are demonstrating," Holt said in a note on Tuesday.

Holt points out that second quarter growth of 2.9 per cent may have slightly been below market consensus of a 3.1 per cent rise, but it was still above the 2.8 per cent that the central bank was forecasting.

"There may not be as good a chance to hike in October or December if growth moderates and so, the case for waiting may be weaker than the case for acting now while continuing to emphasize future data dependency," Holt said.

Bank of Canada governor Stephen Poloz has reiterated time and again that the central bank is trying to base its interest rate decisions on economic data.

Holt added that if the case for leaving interest rates unchanged rests on NAFTA uncertainty, then that's a weak reason in his view.

"NAFTA risks will remain well into 2019 even in a best case scenario as negotiations then move toward debate within legislative assemblies and the need to pass any agreement in all three countries," Holt said. "Monetary policy cannot be put on hold until NAFTA risks are resolved.

"Poloz has been clear that he will consider NAFTA risks only as they impact data and there isn't much if any evidence of this so far," he added.

Debt to keep bank 'patient'

But Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, said the central bank is still focusing on issues such as how households with high debt are coping with rising rates, even though the data so far suggests that higher rates have been manageable.

"The slowing housing market and new mortgage rules have caused debt growth to decelerate, but it's going to take time to work off debt burdens and bring debt ratios down," Reitzes said.

"Barring a big burst of sustainable income growth, elevated debt burdens will keep the bank patient." 

Mortgage borrowing fell to the lowest since 2014 in the first quarter of this year as the introduction of new lending rules and rising interest rates started to have an impact.

Meanwhile, Karl Schamotta, director of market strategy at Cambridge Global Payments said the resumption of trade negotiations between Canada and U.S. on the same day as the interest rate decision is enough to "introduce an element of downside risk when the central bank releases its statement."

The Bank of Canada is set to make its policy announcement at 10 a.m. on Wednesday.