Update 2: 'The tide begins to turn,' as central bank hikes rate for first time in 7 years

Interest rates

The Bank of Canada has hiked its benchmark interest rate to 0.75 per cent from 0.5 per cent, its first increase in nearly seven years, amid expectations of stronger economic growth this year.

Such a move is bound to increase the costs of mortgages, home equity lines of credit and other loans linked to the big bank prime rates.

The Bank of Canada cut interest rates by a quarter of a percentage point twice in 2015 to help the economy deal with a plunge in oil prices, but governor Stephen Poloz said Wednesday that adjustment has been made.

"The economy can handle very well this move we have today and of course you need to preface that with an acknowledgment that of course interest rates are still very low," Poloz told a news conference in Ottawa.

"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 any future changes to the central bank's key interest rate will depend on economic data in the months ahead.

Economic growth is broadening across industries and regions, and therefore becoming more sustainable, the bank said, with both the goods and services sectors expanding.

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 Canadian 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, the first since September 2010, was widely expected by economists following "hawkish" comments by Poloz and senior deputy governor Carolyn Wilkins in recent weeks.

The hike 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.

The Bank of Canada said it also anticipates exports to pick up in the coming quarters and make an increasing contribution to growth, while business investment is also expected to rise.

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."

Speculation about an interest rate hike came amid a flurry of strong economic news this year, with housing starts figures for last month released Tuesday by Canada Mortgage and Housing Corp. amplifying that.

Scotiabank deputy chief economist Brett House said the difference between the actual and potential output of the economy is narrowing rapidly, so he expects the central bank will move now to keep inflation in check.

"We do believe that this is the beginning of a gradual hiking cycle from the Bank of Canada," House said.

While inflation remains well below the central bank's target of two per cent, Poloz said in a recent interview with a German newspaper that if the central bank only watched and reacted to inflation, it would never reach its inflation target and it would always be two years behind in the reaction. He said he has to look at other indicators in the models that predict inflation.

Nick Rowe, a Carleton University economics professor and member of the C.D. Howe council, said inflation remains below the Bank of Canada's target even though other areas of the economy seem to be doing well.

"We simply haven't seen the rise in inflation that you would have expected to have seen as the economy strengthens, plus there aren't really much signs of expected inflation either," said Rowe, who voted to keep the rate on hold.