OTTAWA (Reuters) - The Bank of Canada kept its rate hike options open on Thursday amid doubts about the world economic recovery.
Speaking two days after the bank nudged rates higher for the second time in six weeks, Governor Mark Carney said he shared the view from the U.S. Federal Reserve that the world economic outlook is unusually uncertain.
"Risks around the projection are elevated and there is no preordained path for interest rates in this country," Carney told reporters after the bank released its quarterly report of monetary and economic forecasts.
The report stated explicitly for the first time that its outlook assumes "a gradual reduction in monetary stimulus consistent with achieving the inflation target." But the bank also bumped domestic growth forecasts down.
That the bank will continue tightening is no surprise, given torrid growth in late 2009 and early this year that led it to twice hike rates by 25 basis points -- once on June 1 and again on Tuesday. Its key interest rate is now 0.75 percent.
But investors wonder whether it will dare raise rates a third time on September 8. As well as cutting quarterly growth forecasts for 2010 on Thursday, the bank said the recovery will be more protracted than it had expected due to the European debt crisis and a soft U.S. recovery.
"The direction of rates seems clear. The unknown remains the relative steepness of the Bank of Canada's rate escalation ladder," said Stewart Hall, economist with HSBC Canada.
Canada's growth streak and rate hikes contrast sharply with the situation in the United States, where Fed Chairman Ben Bernanke says he is ready to ease monetary policy further if the budding economic recovery withers.
Carney said he shared Bernanke's caution on the economy.
"The Chairman used the expression 'unusually uncertain.' I would equate them," he said. But he said the prospect of a new slide into recession in the United States was "very low."
Markets are now pricing in a 46.6 percent chance of a 25 basis-point increase in benchmark rates on September 8, according to Thursday's yields on overnight index swaps that reflect expectations for the policy rate.
"This is not a dovish central bank," Scotia Capital said in a note. "It seems a mere truism to point out that dovish central banks don't hike and explicitly state they will withdraw more stimulus in a balanced risks environment."
In its report, the Bank of Canada said the global economic recovery was "proceeding but is not yet self-sustaining."
It cut its second-quarter annualized growth forecast to 3 percent from 3.8 percent, lowered its third-quarter forecast to 2.8 percent from 3.5 percent and reduced the fourth quarter forecast to 3.2 percent from 3.5 percent.
It said low interest rates and fiscal stimulus pulled forward consumer spending and housing investment, which triggered the initial sharp economic rebound.
But as time goes on, spending will soften and a weaker Canadian dollar will boost demand for exports. It assumes the Canadian dollar will average 96 U.S. cents in the coming quarter, down from a 99 U.S. cents estimate last quarter and repeated a plea for more investment and better productivity.
"The need to invest is clearly there because of international competition, because of domestic expansion...and also the need to increase productivity in this country," Carney said.
"So all the conditions are there. It has been remarkably subdued over the course of the recession and the early stages of the recovery. We do expect that to turn around."
The bank sees inflation below or near its 2 percent target through the end of 2012, reflecting lower-than-expected commodity prices, declining wage pressures and expectations businesses will pass tax refunds on to consumers.
It said some of the risks to its outlook, such as European debt concerns, remain elevated. But momentum from emerging market economies could be stronger than currently thought.
The effects on Canada of Europe's debt crisis have been modest so far and felt mainly through lower commodity prices, the bank said. It sees the crisis shaving 0.1 of a percentage point off 2010 growth and 0.3 percent of a point next year.
Reporting by Louise Egan and Ka Yan Ng; Editing by Jeffrey Hodgson and Janet Guttsman