Bank of Canada sees strong loonie muting growth

Wed Jan 19, 2011 1:30pm EST
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By Louise Egan and Leah Schnurr

OTTAWA (Reuters) - Canadian growth will pick up speed this year after a sharp slowdown in the third quarter of 2010, but the strong Canadian dollar will mute a much-needed recovery in exports, the Bank of Canada predicted on Wednesday.

The bank, which held its key interest rate steady at 1 percent on Tuesday, issued cautious forecasts and flagged the country's worsening competitiveness in a report that further solidified the market view that rates will remain on hold for some time.

It said that from now on the country's economic recovery will rely more on exports and business investment and less on consumer spending, housing and government stimulus, which have driven growth thus far.

But exporters will have to battle a strong currency, assumed by the bank to remain at parity with the U.S. dollar. The bank also flagged an issue that it sees as a major headwind in the medium term -- Canada is becoming less competitive and losing market share in the United States, by far its top market, to Mexico and other countries because of poor productivity.

Analysts said the bank's Monetary Policy Report reinforced Tuesday's interest rate statement, which markets interpreted as dovish.

Krishen Rangasamy, economist at CIBC World Markets, said that the bank's modest upward revision to economic growth forecasts for this year and next were partly explained by its new assumption that the Canadian dollar will on average stay at parity with the U.S. currency.

"We continue to expect the BoC to resume its tightening cycle in May, taking the overnight rate to 2 percent by year-end," she wrote in a note to clients.

The bank raised rates three times between June and September last year before hitting the pause button. Most of Canada's primary dealers expect another rate increase in the first half of this year, although they differ on the timing.   Continued...

<p>Bank of Canada Governor Mark Carney speaks during a news conference upon the release of the Monetary Policy Report in Ottawa January 19, 2011 REUTERS/Chris Wattie</p>