Bank of Canada inches toward rate hike amid risk to loonie

Tue Apr 12, 2011 12:58pm EDT
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By Louise Egan

OTTAWA (Reuters) - The Bank of Canada laid the groundwork to hike interest rates later this year by raising its 2011 growth and inflation forecasts on Tuesday even as it held policy steady and used less hawkish language than markets expected.

The central bank, as was widely forecast, held its key overnight rate target at 1 percent, but its accompanying statement knocked down the Canadian dollar and lowered market expectations that it would lift rates in May.

The Canadian economy will return to capacity six months earlier than previously expected, by mid-2012, the bank said. Likewise, it shortened the timeline for inflation to hit its 2 percent target, adding the rate would spike to 3 percent in the second quarter of this year.

But it made no signal it was likely to lift borrowing costs at its next decision date on May 31, saying that any such move would "need to be carefully considered" in a repeat of a phrase it has used for the past several months.

In unusually strong language on the currency, it warned that the strong Canadian dollar continued to be a nuisance, hampering the export recovery and depressing prices.

"The persistent strength of the Canadian dollar could create even greater headwinds for the Canadian economy, putting additional downward pressure on inflation through weaker-than-expected net exports and larger declines in import prices," the bank said.

As if to prove the point, Statistics Canada on Tuesday reported a disappointing trade performance in February, with exports falling 4.9 percent and the trade surplus declining to a negligible C$33 million ($34 million).

All in all, the bank took pains to continue sitting on the fence, while keeping alive expectations of a July rate hike.   Continued...