Canada’s big banks will raise their prime lending rates to 3.2 per cent, effective Thursday, after the Bank of Canada boosted its trendsetting policy rate.

The Bank of Canada on Wednesday raised its target policy rate by 25 basis points to 1.0 per cent from 0.75 per cent.

“Recent economic data have been stronger than expected, supporting the bank’s view that growth in Canada is becoming more broadly-based and self-sustaining. Consumer spending remains robust, underpinned by continued solid employment and income growth,” the bank said.

After the central bank’s move, Royal Bank said that it will increase its prime lending rate to 3.2 per cent from 2.95 per cent, effective Thursday. Bank of Montreal, TD Canada Trust, Bank of Nova Scotia and Canadian Imperial Bank of Commerce will also raise their prime lending rates to 3.2 per cent.

Hawkish tone

More Bank of Canada hikes could be on the way. The bank’s statement accompanying the announcement strikes what several economists described as a “hawkish” tone, which means the bank is trying to tell the market that if the economy continues to outpace expectations and the data supports a move, it’s possible the bank could bring in another rate hike before the end of the year.

“The broad tone of the accompanying statement is generally balanced but it leaves the door wide open to further interest rate hikes,” said Derek Holt, head of capital markets economics at Scotiabank. “One should not rule out another hike over the duration of 2017.”

Dave McKay, RBC’s chief executive, told a financial summit in Toronto on Wednesday that increased payments on mortgages and other debts could hit the economy as people have less disposable income to spend elsewhere.

“That’s one of the effects that we don’t talk enough about,” McKay said. “As rates rise, as they did this morning, a greater amount of disposable income is coming out of purchasing power, which will slow down economic growth in other sectors. And that’s not a healthy thing in the long term.”

Wednesday’s rate hike wasn’t a huge surprise. Before the announcement, futures markets had pegged the odds of a 25-basis-point increase at about 50-50. Had the bank decided to hold rates steady, markets were of the unanimous view the bank would bring in a rate increase at its next meeting on Oct. 25.

The country’s big banks usually adjust their own prime lending rates in line with changes to the Bank of Canada’s target rate. Ahead of the Bank of Canada’s announcement, the prime rate at all five of the big banks was 2.95 per cent.

“We’ve been waiting for this for a long time,” said Rob McLister, founder of ratespy.com. “Rates have been rock bottom for an abnormally long time.”

Timing

So why did the Bank of Canada move rates now and not in October? Canada’s gross domestic product grew at an annualized pace of 3.7 per cent in the first quarter and 4.5 per cent in the second.

The Bank of Canada expected the country’s economy to slow a bit in the current third quarter, but things have been more robust than the bank had forecast in its July Monetary Policy Report.

The Bank of Canada said it is not following a specific plan to usher in future interest rate hikes. Rather, it said future decisions will be guided by economic data and financial markets, and the impact those might have on inflation.

In an interesting move, the bank added that it will pay “close attention” to the impact future rate hikes might have on household debt. The most recent Equifax national consumer credit trends report found that Canadian consumer debt climbed to $1.769 trillion during the second quarter, up from $1.666 trillion a year ago.

Regina Malina, senior director of data and analytics at Equifax Canada, said that for now, Canadian consumers seem to be paying back debt on time. That trend should continue so long as interest rates increase in a gradual fashion and employment markets remain strong, she said.

“It all comes down to how quickly it’s going to happen. If it’s going to happen slowly enough, Canadians should, in theory, be able to adjust to the changing environment,” Malina said. “Delinquency rates are still relatively low.”

Target rate

The Bank of Canada’s interest rate hike puts the target rate back where it was before the oil price shock in 2015. Two years ago, the bank cut the rate to 0.5 per cent to help Canada deal with the drop in oil prices. The bank’s rate hikes in July and on Wednesday reveal that the bank no longer believes the economy needs an emergency boost.

“The statement was replete with upbeat messages on the economy and the view that low inflation may not last,” said Douglas Porter, chief economist with BMO Financial Group.

Porter thinks its possible the bank might raise its target rate as high as 2.0 per cent by the end of next year. Prior to Wednesday’s announcement, BMO had expected the central bank’s policy rate would top out at 1.5 per cent in 2018.

“The somewhat aggressive hike and the upbeat view on growth point to more tightening than we previously expected over the next year,” Porter said.

Financial Post with Canadian Press
dhasselback@nationalpost.com
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