OTTAWA _ The Bank of Canada’s decision to leave its interest rate unchanged Wednesday could be just a brief pause that comes as it carefully follows the unpredictable twists in the country’s trade talks with the United States.

The central bank kept its benchmark at 1.5 per cent, but many experts predict another increase could arrive as early as next month.

In a statement Wednesday, the Bank of Canada said more hikes should be expected thanks to encouraging numbers for business investment, exports and evidence that households are adjusting to pricier borrowing costs.

The bank, however, also made a point of saying it’s closely watching the renegotiation of the North American Free Trade Agreement and other trade policy developments, which could have negative impacts on the Canadian economy. It’s particularly concerned with the potential implications for inflation.

Last week, U.S. President Donald Trump announced he had reached a bilateral trade agreement with Mexico that would replace the three-country NAFTA. He put pressure on Canada to join the U.S.-Mexico deal, but after fresh talks restarted last week Ottawa and Washington have so far been unable to reach an agreement.

Trump notified Congress last Friday of his intention to sign a trade agreement in 90 days with Mexico _ and Canada, if Ottawa decides to join them. If a deal can’t be reached, the president has also repeatedly threatened to impose punishing tariffs on Canadian auto imports.

Frances Donald, senior economist for Manulife Asset Management, said the Bank of Canada’s explicit mention of NAFTA in Wednesday’s statement suggests the negotiations have become even more important around the governing council’s table.

“They’re sending a message that everything looks as planned… What that says to me is that an October rate hike is still certainly in play,” Donald said about the

However, she said the NAFTA reference gives the Bank of Canada options to possibly stay on hold next month, particularly if trade talks _ and the outlooks for the economy and inflation _ deteriorate.

Governor Stephen Poloz, she added, has been “fairly agnostic” on the outlook for NAFTA. She said he’s pointed to potential negatives as well as positives, while the stressing everything is hypothetical until something is decided.

Benjamin Reitzes of BMO Capital Markets wrote in a note to clients that Wednesday’s statement makes it clear the NAFTA talks are biggest issue for markets and the Bank of Canada at the moment.

“There’s big time risk here, but most are still expecting a deal to get done,” Reitzes wrote as he referenced the apparent month-end deadline for NAFTA negotiations.

“Assuming all goes well with NAFTA (perhaps a big assumption) and the data over the next seven weeks, an October rate hike still looks like a reasonable expectation.”

Poloz has raised the rate four times since mid-2017 and his most-recent quarter-point increase came in July. The next rate announcement is scheduled for Oct. 24.

The Bank of Canada said Wednesday that the economy has seen improvements in business investment and exports despite persistent uncertainty about NAFTA and other trade policy developments.

“Recent data reinforce governing council’s assessment that higher interest rates will be warranted to achieve the inflation target,” the bank said as it explained the factors around its rate decision.

“We will continue to take a gradual approach, guided by incoming data. In particular, the bank continues to gauge the economy’s reaction to higher interest rates.”

The statement also pointed to other encouraging signs in Canada, including evidence the real estate market has begun to stabilize as households adjust to higher interest rates and new housing policies. Credit growth has moderated, the household debt-to-income ratio has started to move down and improvements in the job market and wages have helped support consumption, it said.

The bank can raise its overnight rate as a way to keep inflation from running too hot. Its target range for inflation is between one and three per cent.

Heading into Wednesday’s rate decision, analysts widely expected Poloz to hold off on moving the rate _ at least for now.

Last month, Poloz stressed the need to take a gradual approach to rate increases in times of uncertainty. He made the remarks during a panel appearance at the annual meeting of central bankers, academics and economists in Jackson Hole, Wyo.

Improvements in the economy have led to the Bank of Canada’s governor Stephen Poloz vowing to increase interest rates but will September see a hike?

Unlikely, according to two leading economists.

Avery Shenfeld from CIBC Economics says that the BoC will typically announce an increase following strong economic data but that early signs for Q3 do not make a compelling case for a rate rise.

He points out that, while Q2 showed some positive signs, one quarter does not hide an underlying weakness in exports and related capital spending. And inflation is not running away from BoC targets.

Therefore, he expects a hold-steady for interest rates this month, although notes that if NAFTA is agreed then a rate rise won’t be far away.

Over at TD Economics, the expectation is also for Governor Poloz to stand pat this week and to sound a generally positive tone.

“Although the Bank will no doubt continue to emphasize a gradual normalization path with a heavy focus on data dependency, we expect the Bank will be encouraged by economic data over the last six weeks. Notably, the housing market has attained a modicum of stability, while Poloz has consistently stated that the Bank will only incorporate tariffs into their forecast when they are implemented,” the team’s latest report states.

Croft Axsen recently had to inform a client wanting to buy a $300,000 house that he didn’t qualify, so the client instead decided to buy a $95,000 truck. According to Axsen, it is but one example of how easily credit debt can accrue, and how it’s more detrimental to Canadian households than mortgage debt.

“I get it’s easier for the government to regulate mortgage debt, but I’m not sure they’re doing consumers any favours by saying, ‘We’re going to control whether you can buy a house or not, but we’re not going to control whether or not you can buy a $95,000 truck,” said Axsen, owner of Dominion Lending Centres Jencor Mortgage Corporation.

“Instead of buying an appreciating asset, he buys a truck with a bigger payment. By the time the seven-year loan is over, the truck will be worth virtually nothing.”

Canadian mortgage debt has surpassed the trillion dollar mark, and that is worrying the government, but DLC President Gary Mauris says there’s a much bigger problem.

“Unsecured debt is the biggest problem,” he said. “The sheer cost and monthly maintenance of unsecured debt is worrying. Credit card debt, line of credit debt and department store debt are what’s strangling Canadians. Unfortunately, there’s so much pushback from Canadian chartered banks, and it’s such a large business, that the government doesn’t want to take that fight on, so they look at mortgage debt instead. They should be looking at ways to limit unsecured debt, if anything. It’s much higher and much riskier debt, and it’s what we typically see strangling homeowners.”

Mauris can scarcely recall a time when the Canadian housing market endured as much tumult as it is today. He says that, fortunately, lenders and brokers have become creative—and the latter, in particular, have become even more indispensable to the Canadian public—but it’s still bewilderingly difficult to qualify for a mortgage in 2018.

Even more confusing is the fact that tighter mortgage qualification rules merely push homeowners into more expensive financing channels.

“It’s pushing Canadians into more expensive financing like B, where it used to be A,” said Mauris. “You’re making your consumers pay more for mortgage financing. Overall, we’re in a dog fight and it’s become more important than ever before to work with mortgage agents.”

Axsen understands the imperative not to expose mortgage insurers, but he doesn’t understand why ingenuity is an afterthought.

“I get they’re concerned about CMHC being exposed and the danger to the Canadian taxpayer if CMHC ever gets stressed by something with the housing market, but why not come up with a unique product? You can refinance, but the amortization has to be shorter. Or perhaps make it a higher premium on the refinance debt portion, yet still let them use their house to get away from higher credit card debt or lines of credit debt. It seems like the management of debt could have been done in a way that’s better for the consumer and limits the exposure of CMHC and other insurers.”

Credit cards have a higher arrears ratio than mortgages, however, they’re more profitable for banks—and therein lies the rub.

“There are systems in place to control mortgages, so it’s a lot easier than it would be for the government to tell banks how to give someone a consumer loan, a charge card or line of credit,” said Axsen. “They can appear to be these magnanimous, wonderful guys trying to control debt, and being thoughtful about the whole process, but it would be much harder for them to sit bankers down and say, ‘Okay, let’s look at all this other debt and how you’re making decisions to lend it.’”

This morning, Stats Canada released the second quarter GDP figures indicating a sharp rebound in growth to its most robust pace in a year. Real gross domestic product growth accelerated to 2.9% (all figures quoted in annual rates), up sharply from the 1.4% pace in Q1. The Q2 result is only slightly above the Bank of Canada’s 2.8% forecast released in the April Monetary Policy Report, tempering the expectation of a BoC rate hike at next Wednesday’s policy meeting.

First quarter growth had been depressed by a plunge in housing* (see note below), which fell by a whopping 10.5% annual rate in Q1. Investment in housing increased to a modest 1.1% annual rate in the second quarter. Declines in ownership transfer costs continued, but at a more modest pace than in Q1, while new residential construction contracted for the first time since the third quarter of 2016. However, these declines were more than offset by a sharp gain in outlays for renovations.

The strengthening growth in Q2 mainly reflected a surge in exports (+12.3%)–the biggest quarterly gain since 2014–due in part to notable increases in energy products and consumer goods, particularly pharmaceutical products. Exports of aircraft, aircraft engines, and aircraft parts increased sharply on higher shipments of business jets to both the U.S. and non-U.S. countries. Exports of services edged down a bit. Net exports (exports minus imports of goods and services) grew at a 6.5% annual rate in Q2 compared to 4.2% in the prior quarter.

Also boosting growth was stronger consumer spending. Household final consumption expenditure (+2.6%) increased at more than twice the pace of the first quarter, reversing the downward trend over the previous three quarters. Growth was attributable primarily to outlays on services (+3.2%), which outpaced outlays on goods. Housing-related expenses (housing, water, electricity, gas and other fuels), up at a 2.4% annual rate, contributed the most to the widespread growth in consumption of services.

Household spending on goods grew at a 2% annual rate following a flat first quarter, with rebounds in semi-durable and non-durable goods. Purchases of vehicles declined at a 2% annual rate. One negative in the consumption numbers may be that the increased spending was financed by a lower household savings rate. The consumer saving rate fell to 3.4% in Q2 compared to 3.9% in Q1 and 4.5% in the final quarter of last year.

Despite the sharp improvement in growth in Q2, market watchers might be disappointed as slowing business investment brought growth in below the 3.5% forecast of some Bay Street economists. The Canadian dollar dropped in immediate response to the report.

Business investment in non-residential structures, machinery and equipment and computers and computer peripheral equipment decelerated to its slowest pace since the fourth quarter of 2016, which might well have reflected the uncertainty surrounding the renegotiation of NAFTA and the imposition of tariffs on a growing number of Canadian exports to the U.S. Business sentiment and investment in capital formation is an important leading indicator of future growth, so the Q2 slowdown bodes poorly for the outlook. Most analysts are forecasting a marked slowdown in GDP growth in the current quarter to less than 2%.

Interest Rate Outlook

In light of the deceleration in business investment, the Bank of Canada has little reason to hike interest rates at the Bank’s next policy meeting on September 5. Investors are betting that a rate hike in October is a near certainty according to Bloomberg Canada.

Bank of Canada Governor Stephen Poloz played down inflation worries and the prospect of aggressive interest rate increases last week at a Fed conference in the U.S. Poloz argued that the recent spike in inflation to 3% in July, the highest in the G-7, was due to transitory factors that would eventually be reversed. The wage measures in today’s GDP report, along with the separate May employment earnings numbers, point to the Bank of Canada’s ‘wage-common’ measure rising 2.4% in Q2,  little changed from the increase in the first quarter.

Even though Canada is bumping up against capacity constraints and labour shortages are rising, Governor Poloz appears to be in no hurry to bring interest rates all the way back to non-stimulative levels. He has repeatedly made a case for gradualism citing heightened uncertainty over geopolitics and trade as well as economists’ inability to measure critical parameters like potential growth.

The Bank of Canada has raised its benchmark interest rate four times since July 2017 to cool the economy, and market indicators suggest investors are expecting as many as three more hikes over the next year, after which the central bank is anticipated to go into a long pause. That will leave the target for the benchmark rate, currently at 1.5%, at 2.25%–below the 3% “neutral” rate the Bank estimates as a final, non-stimulative resting place for overnight borrowing costs.

• new residential construction;
• renovations; and
• ownership transfer costs.

New residential construction is the most significant component. Renovations to existing residential structures are the second largest element of housing investment. Ownership transfer costs include all costs associated with the transfer of a residential asset from one owner to another. These costs are as follows:

• real estate commissions;
• land transfer taxes;
• legal costs (fees paid to notaries, surveyors, experts, etc.); and
• file review costs (inspection and surveying).

Statistics Canada announced this morning that employment increased in July and the jobless rate fell .2 percentage points to 5.8%–returning to its lowest level since the 1970s posted earlier this year.

The economy added a stronger-than-expected 54,100 net new jobs last month–its most significant advance this year. This gain, however, was driven by increases in part-time work. July’s jobs surge followed the 31,800 rise in June. Both months enjoyed advances well above the 20,000 average monthly gains of the past year.

In the 12 months to July, employment grew by 246,000 (+1.3%), largely reflecting growth in full-time work (+211,000 or +1.4%). Over this period, the total number of hours worked rose by 1.3%.

The job growth last month was primarily in public sector jobs, especially in educational services mainly in Ontario and Quebec. At the national level, the rise was primarily in employment in post-secondary institutions, particularly universities, and was mostly in part-time work. The number of people working in health care and social assistance also rose, mainly in Ontario. In British Columbia, the number of people working increased by 11,000 and the jobless rate was 5.0% (see table below). Job gains were also noted in Newfoundland and Labrador, the first increase since October 2017. The number of workers declined in Saskatchewan and Manitoba, while it was little changed in other provinces.

Manufacturing jobs declined by 18,400 in contrast to the record-high jump of 90,500 in the service sector. The surge in service sector employment, however, likely reflected a technical distortion. The timing of hiring in the education sector has been volatile over the summer months in recent years causing a seasonal adjustment problem. The July spike education jobs will likely be unwound in the next two months.

Wags gains slowed during the month, with average hourly wages up 3.2% y/y compared to 3.6% y/y in June. Wage gains for permanent workers were 3%, the slowest this year.

The Canadian economy continues to run at a stronger pace than long-run potential as the labour markets continue to tighten. The jobless rate of 5.8% is below the full-employment level of 6.0%-to-6.5%. A more robust pace of hiring runs the risk of further increasing excess demand, putting upward pressure on inflation. In consequence, the Bank of Canada will continue to withdraw stimulus by gradually hiking overnight rates.

This report has raised the likelihood of another increase in the benchmark overnight rate of 25 basis points, possibly as soon as the next policy meeting in September. Inflation, however, remains at the Bank of Canada’s target of 2.0%, allowing the Bank to wait until the subsequent meeting in October.

The CMHC wants the Canadian Revenue Agency to provide more robust verification of incomes stated on mortgage applications.

The call comes following an investigation by the CMHC into the correlation between incomes stated on mortgage applications and those reported to the CRA.

It now wants the tax agency to take a “more direct and formal role” in verifying incomes according to documents obtained by Reuters.

Some other countries including the US and UK have systems where the tax agency does provide lenders with verification of mortgage applicants’ incomes and the CMHC believes this would cut potential incidents of mortgage fraud, which can have a serious impact on the economy, especially if there is another financial crisis.

The CRA told Reuters that it is looking into ways that it can respond to CMHC’s concerns and provide lenders with income verification.

While the majority of Canadians are honest on their applications, a recent study by Equifax found that 13% think it’s ok to lie on a mortgage application and 16% believe mortgage fraud to be a “victimless crime”.

The study of mortgages originated between 2013 and 2016 found a 52% spike in suspicious mortgages, mostly in the highest priced housing markets.

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.”