Bank of Canada turns upbeat but holds rates

Thu Mar 8, 2012 8:40pm EST
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By Louise Egan and Randall Palmer

OTTAWA (Reuters) - The Bank of Canada issued a more upbeat outlook for the Canadian and global economies on Thursday, suggesting that an interest rate hike may be back on its radar screen, albeit not immediately.

The central bank maintained its overnight lending rate target at 1 percent, mirroring decisions by the European Central Bank and the Bank of England and extending its freeze on borrowing costs for an 18th month.

In a statement, it said the Canadian economic outlook was "marginally improved", uncertainty around the global economy had decreased and the profile for inflation was somewhat firmer than it had foreseen.

It also warned about the dangers of high household debt levels in a sign of increasing worry about Canadians taking on too much mortgage debt at ultra-low rates. Canada's housing market has been strong, prompting some talk of a housing bubble or a price correction of some sort.

"Canadian household spending is expected to remain high relative to GDP as households add to their debt burden, which remains the biggest domestic risk," the bank said.

The Canadian dollar firmed to C$0.9925 versus the U.S. dollar, or $1.0076, immediately after the announcement, up from C$0.9955, or $1.0045, going into the statement.

The more hawkish language sent short-term bond yields higher as traders priced in the possibility the central bank will tighten policy sooner than previously thought. The yield on the two-year Canadian government bond, which is especially sensitive to Bank of Canada interest rate expectations, rose to 1.154 percent from 1.139 percent just before the release.

Yields on overnight index swaps showed traders had all but ruled out the prospect of rate cuts this year, whereas they had been pricing in a rate cut for the past few months.   Continued...

A pedestrian holding an umbrella walks past the Bank of Canada building during a snow fall in Ottawa January 17, 2012. REUTERS/Chris Wattie