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OTTAWA (Reuters) - The Bank of Canada held its key interest rate at a record low on Tuesday, as expected, and changed growth forecasts only slightly, highlighting weak U.S. demand and a strong Canadian dollar as risks to the 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.
While sounding marginally more upbeat on the global economic outlook and noting stronger-than-expected inflation in Canada, the bank balanced those views by cautioning about the "considerable" slack in the economy and the lack of private sector stimulus so far in the recovery.
Overall, the bank upheld the status quo on rates and gave no indication of when it might start tightening.
"They're clearly on hold until at least the third quarter and they see the risk being quite balanced with the strength of the Canadian dollar being a core risk as well as the global growth outlook from here," said Camilla Sutton, currency strategist at Scotia Capital.
The bank nudged down its growth outlook for this year to 2.9 percent from 3.0 percent but sees 2011 growth of 3.5 percent compared with 3.3 percent previously. 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 said policy support continued to motor Canadian growth along with increased confidence, improved financial conditions, global growth and better export prices.
"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," it said.
The language on the currency was unchanged from previous statements. The Canadian dollar hit a three-month high last week and is expected to touch parity with the U.S. dollar at some point this year, though markets expect it to gradually weaken overall in 2010.
The Canadian dollar weakened after the announcement to hit a session low of C$1.0350 to the U.S. dollar, or 96.62 U.S. cents, its lowest level since January 13. It was at C$1.0305 just before the news.
Yields on overnight index swaps, which trade based on expectations for the key rate, edged lower after the statement, showing the market saw tightening as slightly less likely. Still, the market suggests the rate will be around 0.50 percent in July and 1 percent in December.
PMO's Porter said it appeared the market viewed the statement as being "ever so slightly dovish".
The bank 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.
It had left open the possibility of an even slower recovery in December, when it said capacity would be reached at some point in the second half of 2011.
The economy ran at 3 1/2 percent below its production capacity in the fourth quarter, and "considerable excess supply remains", it said.
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 historically 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.
Additional reporting by Ka Yan Ng, Jennifer Kwan and Claire Sibonney in Toronto; Editing by Jeffrey Hodgson