OTTAWA - The Bank of Canada hiked short-term interest rates for the second time in as many months on Tuesday in what analysts called an attempt to slow down household borrowing in the face of less rapid economic growth.
As expected, the central bank raised it's trendsetting policy rate a quarter point to 0.75 per cent, following a similar increase in June,.
But the central bank did provide a mild surprise by acknowledging the economic recovery will unfold more slowly than it previously thought, scaling back the growth forecast by two-tenths of a point for this year and next to 3.5 per cent and 2.9 per cent respectively.
And it moved back the projection for the economy returning to full capacity from the spring of 2011 to the last quarter of the year.
The rate hike will likely have an impact on variable mortgages as the big commercial banks usually adjust their prime rates shortly after the Bank of Canada adjusts its key lending rates.
But with household debt continuing to rise, BMO Capital Markets economist Michael Gregory said governor Mark Carney was clearly concerned about Canadians getting in over their heads.
"There are risks posed by rates being too low for too long and I believe those risks are beginning to crystallize. When credit is cheap, people consume more of it than perhaps is optimal over the long haul," Gregory said.
Stephen Lingard of Franklin Templeton Managed Investment Solutions said the bank had also given itself more room to cut rates in the future if the economy turns sour.
"What central bankers don't want is a situation like Japan where policy rates are at zero and they have no ammunition left to stimulate the economy, so the governor is trying to normalize rates at a period when the economy is doing well," he said.
The market appeared to react more to the dovish tone of the bank statement than to the rate hike, with the loonie falling slightly on the news.
Market expectations of a rate increase at the next announcement date in September dropped from 65 per cent to 45 per cent, Gregory said.
In addition, CIBC chief economist Avery Shenfeld said yields on longer-term bonds had actually fallen following the announcement because of Carney's dovish tone, meaning longer-term borrowing costs may come down.
The weaker growth trajectory has essentially given the bank an additional six months to get interest rates back to more normal levels, Shenfeld said.
In an accompanying statement, the central bank's governing council flagged several downside risks, including sovereign debt issues in Europe, "uneven" private demand in the United States, and a global recovery that is not yet self-sustaining.
In Canada, the council said the recovery is still being led by government and consumer spending, but noted housing has slowed, and while employment growth remains strong, business investment is being held back by global uncertainties.
"This revision reflects a slightly weaker profile for global economic growth and more modest consumption in Canada," the bank said.
"Given the considerable uncertainty ... any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments," it added.
The next scheduled interest rate announcement is Sept. 8.
The central bank's governing council did not expand on its reasoning for the rate hike other than to say it is consistent with achieving its two per cent inflation target, and noting that at 0.75 per cent, it considers monetary policy to be considerably stimulative.
Although growth will be slower in the next two years, the bank did lift its projection for 2012 to 2.2 per cent from the 1.9 per cent it had earlier forecast.