The Bank of Canada (BOC) may have taken a big gamble on its economy when adopting a new hawkish tone on Wednesday, according to one economic research company.
The central bank raised interest rates to 0.75 percent from 0.50 percent – its first hike in seven years. Investors had prepared for such move but the BOC took a more hawkish tone than expected, mainly when it came to inflation.
Inflation figures have eased over recent months, but the bank said this was a temporary move and it is already registering some pressure from food, electricity and automobiles.
"The BOC expects excess capacity to be absorbed with inflation returning to 2 percent in 2018. We have a different view on inflation, which we see below 2 percent even in 2018," analysts at Bank of America Merrill Lynch said in a note on Wednesday, explaining that oil prices will keep headline inflation low.
However, there are other economic worries in Canada. According to David Madani, senior Canada economist at Capital Economics, the BOC's decision "is a gamble that might have to be reversed before long."
"With the housing bubble already showing signs of bursting and household debt at extremely high levels, higher borrowing costs will dampen economic growth and pushing core inflation even further below target," Madani added. Higher interest rates make mortgages more expensive and thus squeeze household incomes.
In May, the International Monetary Fund (IMF) warned Canada that its housing market imbalances had risen. "The $1.5 trillion (Canadian dollar) mortgage market has been important in sustaining private consumption but households are highly indebted and housing affordability, particularly in Vancouver and Toronto, has become a social issue with many first-time buyers priced out of the markets," the IMF noted in its report.
Indeed, the housing market seems a pressing issue in spite of many economic positives including gross domestic product (GDP) growth.
Where does it go from here?
Despite the housing market, some analysts believe the BOC will announce further rate hikes. Citi analysts predict two rate hikes this year (including Wednesday's hike) but no more until the second half of next year. BoAML expects another rate hike in January of next year but says such decisions will be "data dependent".