OTTAWA _ The Bank of Canada raised its benchmark interest rate Wednesday in an economy that it predicts will remain resilient even as it faces an even bigger bite from deepening trade tensions.

The rate hike was the central bank’s first interest rate move in six months and lifted the trend-setting rate to 1.5 per cent, up from 1.25 per cent. It was the bank’s fourth rate increase over the last 12 months.

The decision, a move that will likely prompt Canada’s big banks to raise their prime rates, arrived in the middle of a trade dispute between Canada and the United States that’s expected to hurt both economies.

The bank took the step even as it predicts larger impacts from the widening trade uncertainty, particularly after the United States imposed steel and aluminum tariffs on Canada and Ottawa’s retaliatory measures. The tariff fight, the bank estimated, will shave nearly 0.7 per cent from Canada’s economic growth by the end of 2020.

However, the bank expects the negative blow of the trade policies recently put in place to be largely offset by the positives for Canada from higher oil prices and the stronger U.S. economy.

“Although there will be difficult adjustments for some industries and their workers, the effect of these measures on Canadian growth and inflation is expected to be modest,” the bank said in a statement.

But in addition to steel and aluminum tariffs, Canada is facing a significant trade-related unknown that many believe would inflict far more damage on the economy: U.S. duties on the automotive sector

U.S. tariffs on the auto sector’s integrated cross-border supply chains would have “large impacts on investment and employment,” the Bank of Canada warned Wednesday in its accompanying monetary policy report.

The bank, however, didn’t quantify the possible effects of auto tariffs on Wednesday. Governor Stephen Poloz has signalled in the past that he’s focused on data he can measure rather than the impacts of trade policies that have yet to materialize.

Canadian businesses must also contend with the uncertainty surrounding the difficult renegotiation of the North American Free Trade Agreement, for which talks have stalled.

The Bank of Canada also has its eye on how widening global trade disputes, including an intensifying battle between the U.S. and China, will affect the world’s economy. It warns that “escalating trade tensions pose considerable risks to the outlook” at the global level.

Even with the trade issues, the Bank of Canada is now predicting slightly stronger growth for Canada over the next couple of years, according to updated projections it released Wednesday in its quarterly monetary policy report.

It expects real gross domestic product to grow 2.2 per cent in 2019, up from its April call of 2.1 per cent, and by 1.9 per cent in 2020, compared with its previous prediction of 1.8 per cent. The economy’s growth projection for this year remains at two per cent, the bank said.

Looking ahead, the bank predicts Canadian growth will continue to see bigger contributions from exports and business investment, which were both stronger than expected in the first three months of the year.

At the same time, household spending will represent a smaller and smaller share of overall growth due to the dampening effects of higher interest rates and stricter mortgage rules, it said.

Leading up to the announcement Wednesday, Poloz was widely expected to raise the interest rate following a run of healthy economic numbers, including the Bank of Canada’s own survey on business sentiment, tightened job markets and growth in wages.

Moving forward, the bank said it expects higher interest rates will be necessary over time to keep inflation near its target, however, it intends to continue along a gradual, data-dependent approach.

The country’s inflation rate is expected to rise to 2.5 per cent _ above the two per cent mid-point of the bank’s target range _ due to temporary factors such as higher gasoline prices before settling back down to two per cent in the second half of 2019.

There appears to be little relief in sight for Canadian homebuyers, especially first-time buyers, as affordability is likely to worsen.

A report published Tuesday by RBC Economics says that rising interest rates took a bite out of housing affordability in the first quarter of 2018 and things are not looking brighter for the near future.

Average Canadian households had to allocate 48.4% of their income to housing costs in the first quarter, a rise of 0.4 percentage points from Q4 2017 and a new multi-decade high.

“Higher mortgage rates were the main contributor to the rise in ownership costs,” said Craig Wright, Senior Vice-President and Chief Economist at RBC. “With the prospect of more interest rate hikes in the period ahead, there’s a definite risk that affordability will erode further in the coming year. The odds of this occurring will also depend on the degree to which household income increases.”

RBC Economics’ Housing Trends and Affordability Report reveals that things had improved in the fourth quarter of 2017 as easing home prices helped offset rising interest rates. But nationwide prices were flat at the start of 2018.

Affordability improved in Toronto, slightly
Toronto did see some improvement with prices declining in Q1 2018. However, the 0.1 percentage point improvement in the housing affordability measure still means households needed 74.2% of their income for housing costs.

There was also an improvement in affordability in Winnipeg, while the quarterly increase in RBC’s aggregate measure in Saskatoon, Ottawa, Halifax and St. John’s was the largest in more than a year.

Montreal faced a third-straight rise in its measure, reaching its highest point since 2011.

Vancouver continues to push household budgets to the limit with homeowners needing to allocate an eyewatering 87.8% of their income to housing costs following a rise of 1.5 percentage points.

Interest rates to hit 2.25%
“Interest rates will be crucial to the outlook for housing affordability in the year ahead,” continued Craig Wright. “Our view is that the Bank of Canada will proceed with a series of rate hikes that will raise its overnight rate from 1.25% currently to 2.25% in the first half of 2019. This would have the potential to stress housing affordability significantly.”

Fresh economic numbers from Statistics Canada pointed to a sustained acceleration to beyond 2% growth in Q2 2018 – a necessary condition for the Bank of Canada to proceed with interest rate hikes in the second half of this year, according to a markets observer.

“We’ve passed the first of three hurdles remaining for the Bank of Canada decision on July 11,” Manulife Asset Management senior economist Frances Donald told BNN Bloomberg. “GDP has come in – that’s certainly enough to check the box for the Bank of Canada and a July rate hike.”

The Statistics Canada report released late last week showed that the Canadian economy enjoyed surprisingly strong output, mainly due to the stabilizing real estate and manufacturing segments.

GDP saw 0.1% month-over-month gains in April, defying expert predictions of flat performance. This marked the third straight month of growth after the 0.3% in March and the 0.4% in February.

“All in all, these numbers that you’re telling me right now say it’s a go for a July rate hike,” Donald stated.

Read more: Economy shows the time is right for interest rate hikes – BoC’s Poloz

The Bank of Montreal agreed that the April numbers are promising, although it didn’t directly comment on the possibility of a rate hike.

“While readily acknowledging that a 0.1% rise in headline GDP is not going to send many hearts racing, this actually was a decent result in a challenging month for the economy,” chief economist Doug Porter wrote in a note to investors. “Importantly, it suggests that growth was pretty much in line with the Bank of Canada’s underlying expectations through the spring.”

Real estate agent and broker activity rose by 0.5% in April, the largest jump recorded ever since the implementation of B-20 at the beginning of 2018. Meanwhile, manufacturing went up by 0.8%.

The Bank of Canada will meet to decide on its latest move on interest rates next week and many are expecting an increase.

But once July’s hike is done, things become less clear as the economy is showing some mixed signals.

Two economists from Canada’s big banks have given their assessment of the likelihood of rate rises and both are confident that homeowners are facing higher mortgage costs from this month.

CIBC’s Avery Shenfeld says that the recent GDP and outlook survey were positive and a strong labour force survey for June is also expected.

“That will be the last piece of the puzzle for a Bank of Canada rate hike in July, but we’re also of the view that economic growth will moderate enough after Q2 to force another extended pause on rates,” he says.

Meanwhile, TD Economic’s James Marple is also expecting June’s labour figures to support a July interest rate rise; and concurs with Shenfeld’s call for a pause afterwards.

“Given a more cautious outlook and ongoing threat of escalating trade wars, we suspect it will be some time before we see another hike,” he says.

Marple notes that the housing market has shown some signs of stabilization with  some markets, Ottawa and Montreal for example, showing “decent positive momentum.”