January 18, 2011 / 3:40 PM / in 7 years

Bank of Canada holds rates, signals extended pause

OTTAWA (Reuters) - The Bank of Canada held its key interest rate steady on Tuesday and signaled it may keep rates on hold for longer than markets had expected even though it nudged its economic growth forecasts higher.

The central bank held its overnight lending target at 1 percent for the third straight time after leading the Group of Seven advanced economies last year by raising rates three times between June and September.

“Any further reduction in monetary policy stimulus would need to be carefully considered,” it said in a statement that repeated the language used in its two previous rate decisions.

Canada’s economy snapped back to life in late 2009 after a shallow recession but the initial galloping pace of growth has since slowed to a crawl, leaving policymakers wary of withdrawing extraordinary stimulus measures too soon.

While nobody expected the bank to make another rate move as early as this month, some market players had bet on a more hawkish statement on rates to reflect the spillover effects of recently announced U.S. tax cuts and the U.S. Federal Reserve’s bond-buying program.

The bank did upgrade its economic outlook slightly, but it didn’t change its medium-term forecast for a balanced economy by the end of 2012.

It stressed that the high-flying Canadian dollar was hampering recovery in the export sector, the backbone of the Canadian economy, and that Europe’s debt woes remain a black cloud over the global economy.

Many analysts think the bank is unlikely to push Canadian rates much above their U.S. equivalents because this could send the Canadian dollar to fresh multiyear highs. And Monday’s government decision to curb high household debt by tightening mortgage rules for a second time in less than a year could also let the bank delay a fresh rate hike further.

Those looking for hints about the timing of the next rate hike were disappointed.

“This reaffirms our view that the bank is on a prolonged pause and reinforces our forecast that the next hike isn’t coming until October,” said Derek Holt, economist at Scotia Capital.

“I think (the tone) is consistent with the tone of their speeches and the last rate statement, but it’s a bit more dovish than some in the market might have expected,” he said.

Mark Chandler, head of fixed income and currency strategy at RBC Capital Markets, called it a “very, very cautious outlook”.

“At least for now they don’t see any real benefit in laying cards on the table in terms of expected rate increases,” Chandler said.

Seven of the 11 primary dealers who participated in a Reuters poll on Tuesday forecast the bank will resume raising rates in the first half of the year. But questions remain about the timing of the next hike, with one dealer expecting a March rate rise, compared with three who expected a March move in last week’s poll.

Three now forecast a rise in April and three see a rise in May.

Overnight index swaps, which trade based on expectations for the key central bank rate, showed investors see an 84.36 percent probability rates will stay on hold March 1, compared with 72.85 percent before the statement.

The Canadian dollar extended losses against the U.S. dollar, weakening from a 2-1/2 year high overnight to C$0.9927 against the U.S. dollar, or $1.0074, from C$0.9867, or $1.0135, just before the announcement.

Canadian government T-bill and bond yields fell immediately after the rate announcement, reflecting a scaling back of rate hike expectations. But bond yields later reversed those declines, mirroring weakness in U.S. Treasury prices.

The yield on the rate-sensitive two-year Canadian government bond was 1.793 percent, little changed from before the statement. The 10-year bond was down 35 Canadian cents to yield 3.30 percent.

TOUGHER LANGUAGE ON CURRENCY

The central bank sees the Canadian economy growing by 2.4 percent in 2011 and by 2.8 percent in 2012. Last October it put 2011 growth at 2.3 percent and 2012 growth at 2.6 percent.

It expects business investment to continue to rebound sharply, helping offset the impact of softer consumer spending and a cooling housing market. Net exports will also contribute more to growth in coming quarters despite the strong Canadian dollar, thanks to signs of fresh vigor in the U.S. economy.

But at the same time it toughened its language on the harmful effects of the strong Canadian dollar on the recovery, as some market players had anticipated.

“The cumulative effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance are restraining this recovery in net exports and contributing to a widening of Canada’s current account deficit to a 20-year high,” it said.

The Canadian dollar appreciated 5.7 percent against the U.S. dollar last year and nearly 16 percent in 2009.

The bank’s quarterly Monetary Policy Report, due for release on Wednesday at 10:30 a.m. (1530 GMT), will provide more details on the outlook.

Additional reporting by Leah Schnurr in Ottawa, Solarina Ho, Claire Sibonney and Ka Yan Ng in Toronto; Writing by Louise Egan; editing by Peter Galloway

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