OTTAWA (Reuters) - The Bank of Canada held its key interest rate unchanged on Tuesday, as expected, and nudged down its growth outlook for this year, highlighting a weak U.S. economy and a strong Canadian dollar as threats to recovery.
The central bank kept its overnight lending rate at 0.25 percent and repeated its commitment to hold it there until the end of the second quarter, provided inflation remains tame.
Its view on the economic recovery remains much the same as in October, although it still sees a lot of slack.
"The factors shaping the recovery are largely unchanged - policy support, increased confidence, improving financial conditions, global growth, and higher terms of trade," it said in a statement.
"At the same time, the persistent strength of the Canadian dollar and the low absolute level of U.S. demand continue to act as significant drags on economic activity in Canada."
The bank now expects 2010 growth of 2.9 percent compared with 3.0 percent previously and 2011 growth of 3.5 percent compared with 3.3 percent. It believes the economy contracted 2.5 percent in 2009 versus its previous forecast of a 2.4 percent decline.
"Both 2009 and 2010 have been reduced by a tenth and 2011 has been bumped by two tenths so...basically there's a very little net change in terms of the growth forecast," said Doug Porter, Deputy Chief Economist at BMO Capital Markets.
The Bank of Canada said the economy would return to full capacity in the third quarter of 2011, and inflation would return to the 2 percent target at that time.
In December, it had said capacity would be reached in the second half of 2011.
The Canadian dollar weakened to C$1.0335 to the U.S. dollar, or 96.76 U.S. cents, from C$1.0305 to the U.S. dollar, or 97.04 U.S. cents just before the report. Canadian bond prices held mostly lower.
The yield on the 2-year bond dipped to 1.275 percent, from 1.286 percent just before the announcement.
The central bank said economy ran at 3 1/2 percent below its production capacity in the fourth quarter, and "considerable excess supply remains".
The bank made no explicit mention of how and when it might start raising interest rates from their current record lows. But it did shorten maturities on its term purchase and resale agreements to match maturities more closely to the end-June date when its conditional commitment expires.
It said the outlook for the global economy is a bit better than the bank had expected, but growth remained dependent on historic low interest rates and fiscal stimulus.
The bank will provide more details on its projection on Thursday in its quarterly monetary policy report.
It next sets rates on March 2.
Editing by Janet Guttsman