October 21, 2015 / 2:06 PM / 2 years ago

UPDATE 2-Bank of Canada holds rates, but cuts 2016, 2017 growth forecasts

3 Min Read

(Adds commentary on Trudeau stimulus, Canadian dollar reaction)

By Randall Palmer and Leah Schnurr

OTTAWA, Oct 21 (Reuters) - Canada's central bank held interest rates steady on Wednesday after two cuts earlier this year, judging that the economy was rebounding from an oil price shock, but it warned economic growth in the next two years will be slightly lower than projected.

The central bank held its benchmark rate at 0.5 percent following the reductions it had made in January and July because of the effects of lower oil prices. It said these cuts were helping the economy to recover as expected.

Market analysts pointed out that a promise from the incoming Liberal government of Justin Trudeau of annual deficit spending of up to C$10 billion ($7.6 billion) for three years starting in 2016 was not accounted for in the bank's forecast, making a rate cut even less likely.

"If there was any positive probability of them cutting again this probability disappeared given the fact that we will have fiscal stimulus coming," said CIBC World Markets senior economist Benjamin Tal.

The Canadian dollar weakened against the greenback following the rate decision, touching a session low of C$1.3116, or 76.24 U.S. cents, though lower oil prices also weighed.

The bank said prices for oil and other commodities were dampening business investment and exports in the natural resources sector. This prompted a growth forecast cut to 2.0 percent from 2.3 percent for 2016, and to 2.5 percent from 2.6 percent for 2017.

"In non-resource sectors, the looked-for signs of strength are more evident, supported by the stimulative effects of previous monetary policy actions and past depreciation of the Canadian dollar," it said in the rate decision statement.

The central bank pushed back the time frame for when the economy will reach full capacity to mid-2017 from its July estimate of first-half 2017, as economic slack has increased.

But the bank forecast core inflation will now return sustainably to the 2.0 percent target three quarters earlier than expected, in the third quarter of 2016, and total inflation is now seen returning to target in the first quarter of 2017 instead of the second.

Core inflation strips out volatile elements including gasoline, fruit and vegetables. The bank continued to offer an alternative measure, saying the underlying trend in inflation remained at 1.5 percent to 1.7 percent.

Globally, it saw growth a little weaker than expected this year "but the dynamics pointing to a pickup in 2016 and 2017 remain largely intact."

$1=$1.31 Canadian Editing by W Simon

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