Interest Rates

Bank of Canada sees no early rate hike despite data

December 8, 2009

By Louise Egan

OTTAWA (Reuters) - The Bank of Canada held its key interest rate near zero on Tuesday, as expected, and dampened any expectations of an early rate hike even though it said it sees economic recovery gathering momentum in coming quarters.

The central bank repeated its pledge to hold the overnight rate at 0.25 percent until the end of June 2010, conditional on inflation staying on track.

The decision was widely expected by primary securities dealers surveyed by Reuters but markets were closely watching for any sign the bank would tweak its outlook after a surge in jobs growth in November and other surprisingly upbeat recent data.

The bank stuck to its medium-term projection.

"The main drivers and the profile of the projected recovery in Canada remain consistent with the bank's views in the October Monetary Policy Report," the central bank said in a statement.

The bank walked a fine line between warning of "significant fragilities" in the global economy, and predicting Canadian growth would become more solidly entrenched in coming quarters.

"Their point about 'significant fragilities' is kind of a Canadian version of (U.S. Federal Reserve Chairman Ben) Bernanke's 'formidable headwinds' yesterday," said Derek Holt, economist at Scotia Capital.

"They want to be careful not to rock the boat on rates given what I think are very legitimate questions about sustainability," he said.

The Canadian dollar weakened after the bank's statement on investor disappointment at the cautious tone. The currency fell to C$1.0598 to the U.S. dollar, or 94.36 U.S. cents, from C$1.0572, or 94.59 U.S. cents, earlier. Bond prices remained mostly firmer.

The bank once again flagged the strong Canadian dollar as a major risk to its forecasts, saying it could "act as a significant further drag on growth and put additional downward pressure on inflation."

But it dropped a reference it made in October to risks that the currency could "more than fully offset" favorable economic developments since July. This was an apparent acknowledgment that the currency has already taken a toll on third-quarter annualized growth, which was well below the bank's 2 percent projection at a tepid 0.4 percent.

"That could be a nod in the direction that we've seen some pullback in terms of the Canadian dollar," said Paul Ferley, assistant chief economist at Royal Bank of Canada.

The currency, which had hit a 2009 high on October 15, weakened after the Bank of Canada's remarks in October but began strengthening again in November.

The weakness in the third quarter reflected a shift in the source of growth away from net exports toward final domestic demand, the bank said.

But the bank appeared confident that growth in the fourth quarter and into 2010 would more than compensate for the third-quarter sluggishness and would rely less on fiscal and monetary stimulus.

"For the most part, the bank's view on the economy seems little changed," Ferley said.

"That's despite the fact that the third-quarter numbers came in weaker than expected, which implies they are fully confident of a solid rebound in the fourth quarter," he said.

That leaves open the possibility of rate hikes in the second half of 2010, analysts said. Most of Canada's 12 primary dealers expect the bank to leave rates unchanged until at least the second half of next year but four predict a hike before then.

The bank also upheld its outlook on inflation, although it was less precise about when inflation would return to the bank's 2 percent target, saying that would occur in the second half of 2011 instead of in the third quarter of that year.

Core inflation, which strips out volatile items and is therefore used by the bank to judge underlying price pressures, has been slightly higher than expected, the bank said. But overall inflation has been in line with its predictions. (Additional reporting by Scott Anderson, Ka Yan Ng and Jennifer Kwan in Toronto; editing by Peter Galloway).

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