Bank of Canada announces first interest rate increase since 2010

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The Bank of Canada hiked its benchmark interest rate Wednesday for the first time in nearly seven years in what may be the beginning of the end of the era of cheap borrowing that has fuelled the hot housing market and record levels of debt.

The central bank raised its key interest rate target to 0.75 per cent from 0.5 per cent, the first increase since September 2010, amid rising confidence the economy has turned the corner and expectations of stronger growth ahead.

"The economy can handle very well this move we have today," governor Stephen Poloz told a news conference in Ottawa.

He cited the central bank's "bolstered confidence" in the country's economic outlook, including brighter prospects for exports and business investment, compared to the beginning of the year.

The Bank of Canada cut interest rates by a quarter of a percentage point twice in 2015 to help the economy deal with the plunge in oil prices. But Poloz said the economy no longer needs as much stimulus.

The hike, while incremental, prompted the country's big banks to raise their prime rates, which are used as a benchmark for variable rate mortgages, home equity lines of credit and other loans.

Even with the increase, interest rates remain low from a historical perspective and Poloz said Canadians should be prepared that rates will rise further at some point in the future.

"People need to understand that in the full course of time I don't doubt that interest rates will move higher, but there's no predetermined path in mind at this stage," he said.

Scotiabank chief economist Jean-Francois Perrault said he expects Wednesday's announcement marks the start of a gradual cycle of rate hikes.

Perrault said he's watching carefully to see if exports and business investment deliver as the Bank of Canada is predicting.

"The key thing to the forecast is a pickup in investment and a pickup in export growth because the household side has been doing too much of the heavy lifting," he said.

"If that were to continue, I think that speaks very favourably for growth prospects going forward and kind of a continued gradual pace of increases from the bank."

Senior deputy governor Carolyn Wilkins said the central bank was cautious in the spring because it has been disappointed before when economic data has failed to live up to expectations.

But she said the data since May -- including positive momentum in jobs and exports as well as a broadening of growth across industries and regions -- has helped instil confidence.

Bank of Montreal chief economist Doug Porter said he expects the next rate hike will occur in October, but wouldn't rule out such a move at the central bank's next scheduled announcement on Sept. 6.

"And so the tide begins to turn," Porter wrote in a brief note to clients. "The overall tone of the statement and the bank's updated forecast are on the upbeat side of expectations."

In its outlook for the economy, the Bank of Canada estimated growth to be 2.8 per cent this year, 2.0 per cent next year and 1.6 per cent in 2019. That compared with its April forecast for growth of 2.6 per cent this year, 1.9 per cent next year and 1.8 per cent in 2019.

The rate increase comes as inflation remains below the bank's two per cent target. But it said it believes the recent softness is temporary, with the effects of food price competition, electricity rebates in Ontario and changes in automobile pricing expected to fade. The bank expects inflation to ease further this year due in part to Ontario electricity rebates, but return close to two per cent by the middle of next year.

Consumer spending is expected to continue to be a significant contributor to the economy, but the bank said it believes high levels of household debt and a slowdown in the housing market will weigh on spending.

The announcement follows signs that the housing market, a key economic driver in recent years, is adapting to government changes meant to cool the real estate sectors of Toronto and Vancouver and help improve financial stability.

"Looking ahead, residential investment is anticipated to contribute less to overall growth," the bank said. "Macroprudential and housing policy measures, as well as higher longer-term borrowing costs resulting from the projected gradual rise in global long-term yields, are all expected to weigh on housing expenditures."