Bank of Canada leaves key interest rate unchanged, in no hurry to raise rates

Posted on 09. Mar, 2010 by in News

By Paul Vieira , Financial Post January 19, 2010

OTTAWA — Even though global growth is “somewhat” exceeding expectations, the Bank of Canada indicated Tuesday it is in no hurry to begin raising its benchmark rate as the recovery continues to depend on “exceptional” fiscal and monetary stimulus.

As widely anticipated, the central bank left its benchmark rate unchanged at 0.25%, and reiterated its conditional pledge to keep it at that historically low level until the end of the second quarter in an effort to reach its 2% inflation target.

Most bank watchers were looking to this statement for any changes to the central bank’s forecast and hints it might begin backing away from its conditional rate pledge. Overall, analysts say the statement tried to reinforce caution about the recovery unfolding.

“The renewed and determined commitment to keep rates steady until mid-year can be seen as slightly dovish,” said Douglas Porter, deputy chief economist at BMO Capital Markets.

The main stock index in Toronto was down slightly on the central bank statement, while the Canadian dollar had slipped roughly 40 basis points, to just above US97¢, after hitting a three-month high.

In its statement, the central bank slightly tinkered with its growth forecast, and removed any suggestion that “fragilities” remain in the global economy.

Nevertheless, the central bank suggested its conditional rate commitment remains intact, as “excess” capacity in the economy, persistent Canadian dollar strength and the “low absolute level” of U.S. demand act as “significant” drags on the economy.

The central bank indicated it judges the economy was operating 3.25% below potential in the fourth quarter, compared with 3.5% in the third. Inflationary pressure emerges as the output gap becomes narrower.

“While the outlook for global growth through 2010 and 2011 is somewhat stronger than the bank had projected [in October], the recovery continues to depend on exceptional monetary and fiscal stimulus, as well as extraordinary measures taken to support financial systems,” it said in its statement explaining the rate decision.

The head of the International Monetary Fund, Dominique Strauss-Kahn, also warned during a trip this week to Tokyo that growth was still largely driven by government stimulus and countries risked a return to recession if anti-crisis measures are withdrawn too soon.

The central bank said it does not expect the private sector to emerge as the sole driver of domestic demand until 2011, which is when Canada’s two-year, $46-billion stimulus plan is scheduled to expire.

The Bank of Canada said the recovery in Canada is unfolding as it envisaged, due to policy support, increased consumer confidence, improving credit conditions and improved terms of trade. It envisages the economy returning to full capacity and inflation hitting its preferred 2% target in the third quarter of 2011.

As for its forecast, it now projects Canadian output to expand 2.9% this year, slightly below the 3% growth it expected in October. However, it has upgraded its 2011 outlook, to 3.5% from 3.3%. The economy, it believes, will have contracted 2.5% in 2009 once all the data emerges, or just above the 2.4% drop originally envisaged.

The central bank will expand on its economic outlook on Thursday when it releases its quarterly monetary policy report. But to date, headline growth numbers have missed the central bank’s, and market, expectations. Furthermore, the Bank of Canada has provided among the most bullish forecasts for the Canadian economy.

Andrew Pyle, wealth advisor and markets commentator with ScotiaMcLeod, said the central bank is getting closer to its first official hike since taking the target rate to 0.25% last April.

Still, he added, “embedded in the statement is the same note of caution that what has transpired since the world hit the floor last year has been built largely on fiscal and monetary stimulus and there remains a huge question mark on what happens when the steroids are taken away. Where’s Mark McGwire when you need him.”

Analysts had noted that core inflation was beginning to edge up ahead of the central bank’s forecast. The Bank of Canada acknowledged this was the case but “considerable excess supply remains.” As it happened, the central bank’s business outlook survey released last week suggested inflation expectations among firms had receded due to large levels of economic slack.

Stronger-than-projected global and domestic demand represent the upside risks to the central bank’s inflation outlook, whereas the “persistent strength” in the Canadian dollar and a “more protracted” global recovery could stall inflation growth. (In its last outlook, the bank projected the Canadian dollar to trade at the US96¢ level. The loonie has recently traded above at US97¢.)

Overall, the bank judges the risks to its economic outlook to be roughly balanced, but slightly tilted to the downside on inflation as a consequence of its record-low rate.

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