July 15, 2008 / 1:09 PM / 9 years ago

What the Bank of Canada is considering

OTTAWA (Reuters) - The Bank of Canada appears set to hold interest rates steady on Tuesday, giving itself more time to see how the U.S. economic saga unfolds while trying to prevent high inflation from taking hold in the country.

Canada's primary securities dealers forecast unanimously that the central bank would keep rates at its benchmark overnight rate at 3 percent this month and in September.

Investors will scour the statement that will accompany the rate announcement to see if Governor Mark Carney switches to a more hawkish tone or maintains a neutral stance on rates.

The statement could also contain new projections for inflation or growth because it comes two days before the bank releases an update to its April monetary policy report.

Below is a list of some factors the BoC's governing council will consider when it meets to set rates on Tuesday:

INFLATION

Inflation reached 2.2 percent in the 12 months through May on rising gasoline prices, while consumer prices rose 1.0 percent in May from April, the highest monthly rate since 1991. Core CPI, however, was a tame 1.5 percent. Core CPI excludes volatile items like gasoline and food.

The unforeseen spike in oil prices prompted the bank to forecast CPI inflation would rise above 3 percent later this year. Carney said in June the commodity price shock had prompted him to adopt a "relentless focus on inflation."

The bank may be concerned that inflation expectations are creeping higher. More than a third of business managers surveyed by the Bank of Canada in the second quarter thought inflation would push above 3 percent, the highest number ever for the survey.

Until recently, Canada considered itself relatively immune to the global food price inflation as the rise in the Canadian dollar kept food imports cheap and retailers waged a price war. Many economists believe that immunity is coming to an end.

Wage inflation, however, eased to 4.3 percent in June from 4.6 percent in May.

ECONOMIC GROWTH

Economic growth bounced back in May, growing 0.4 percent, after a 0.3 percent contraction in the first quarter.

The latest data on employment and new housing prices point to cracks in the economy. However, exports -- which have been hit by the U.S. slowdown -- surged to an all-time high in May. Net exports are expected to continue to curb growth.

Domestic demand is robust thanks in part to rising incomes from the commodity boom.

FINANCIAL MARKETS

The bank has said funding pressures in short-term money markets have eased considerably since April but credit conditions are still not back to pre-crisis levels. That has prompted it to become the first G7 central bank to begin withdrawing its liquidity operations in May and to discontinue all emergency loans in June.

Pressures remain in longer-term funding markets and the bank said it will not let down its guard.

Growth in household and business borrowing remained solid in the first quarter of this year, the bank said in its April report.

In the Bank of Canada survey of business managers, the number who said credit conditions had tightened was the lowest since the start of the credit crunch.

U.S. ECONOMY

Canada's growth projections are largely based on the U.S. outlook because three quarters of its exports are sold there. Economists largely expect the United States to dodge a recession but that the recovery will take longer than previously expected.

In April, Carney said the bank's focus is on the length of the U.S. recovery rather than whether it will technically undergo a recession, defined as two consecutive quarters of contraction.

Reporting by Louise Egan; Editing by Frank McGurty

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