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OTTAWA (Reuters) - The Bank of Canada doggedly stuck to the message on Wednesday that it may have to raise interest rates despite a global slowdown, predicting the domestic economy would gain momentum this year and next and inflation return to target within a year.
The central bank held its key overnight rate at 1 percent, as expected, extending a two-year freeze on borrowing costs. In 2010 it became the first Group of Seven country to lift rates from emergency lows following the recession.
But as the U.S. Federal Reserve and other global central banks contemplate further rounds of easing, Canada repeated on Wednesday what it has been saying for months - that the time for removing stimulus could be near.
"To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 percent inflation target over the medium term," the bank said in a scheduled policy announcement, using language identical to its last two rate statements.
The Canadian dollar trimmed losses against the U.S. dollar after the rate announcement. The currency strengthened to C$0.9874 versus the U.S. dollar, or $1.0128, shortly after the announcement. It was trading at C$0.9884, or $1.0117 just before the bank's statement.
There was no sign of backpedaling by Bank of Canada Governor Mark Carney even as he highlighted the weak U.S. recovery, the European debt crisis and decelerating growth in China and other emerging economies.
"(The bank) retains a hawkish bias, with really quite limited changes since July, so those that were expecting a significant shift and more dovish tone are going to be disappointed," said Camilla Sutton, chief currency strategist at Scotiabank.
Still, analysts believe the bank will put off raising rates until the second quarter of 2013, according to a Reuters poll of financial institutions released on August 28.
That view is likely intact.
"There wasn't much meat on these bones ... And I think that's exactly what the bank wants. I don't think they were trying to send any big message here," said Doug Porter, deputy chief economist at BMO Capital Markets.
Despite the bank's rate-hike bias, markets reduced their bets of an increase this year slightly following the bank's statement, according to overnight index swaps, which trade based on expectations for the policy rate.
"We've had some interesting periods over the last few months where what Governor (Mark) Carney has said in terms of a hawkish bias has been totally discounted by markets in the sense that the market just doesn't believe he'll have the ability to tighten policy. I would suspect we continue to see a bit of that," Sutton said.
The bank judges the economy's underlying momentum to be roughly in line with its growth potential. The bank has said the economy's growth potential is about 2 percent, despite being held back by global headwinds and growing only by an annualized rate of 1.8 percent in the second quarter.
"Economic growth is expected to pick up through 2013, with consumption and business investment continuing to be its principal drivers, reflecting very stimulative financial conditions," the bank forecast.
Since the economy is operating near its potential, the bank said it sees core inflation, softer than expected in recent months, returning to its 2 percent target over the next 12 months along with total inflation. Core inflation was 1.7 percent in July and total inflation was 1.3 percent.
Household spending is showing tentative signs of slowing, the bank said, although the overall household debt burden continues to rise. The bank has raised the alarm over a record high household debt-to-income ratio, which has been fueled in part by high housing prices and cheap lending rates.
Additional reporting by Alastair Sharp and Solarina Ho in Toronto.; Editing by Chizu Nomiyama; and Peter Galloway