Bank of Canada holds rates, hawkish tone surprises

Tue May 31, 2011 3:24pm EDT
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By Louise Egan and Randall Palmer

OTTAWA (Reuters) - The Bank of Canada warned on Tuesday that it would eventually have to lift borrowing costs if the economy continues expanding, introducing some hawkish language that caught many in the market off guard.

The statement by the central bank -- which kept its key interest rate unchanged at 1 percent -- drove the Canadian dollar and short-term bond yields higher as traders increased bets on rate hikes later this year.

"To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be eventually withdrawn," the central bank said in a statement.

It added that "consistent with achieving the 2 percent inflation target. Such reduction would need to be carefully considered,"

The markets interpreted "eventually" to mean not the next rate decision in July, but later in 2011.

Previous statements had only said that any future hikes "would need to be carefully considered."

Finance Minister Jim Flaherty, who meets Bank of Canada Governor Mark Carney regularly, told reporters on Tuesday it had been clear for some time that rates would rise, "so consumers ought to bear that in mind when they assume debt."

"It doesn't sound like the central bank is gearing up for a rate hike in July but the warning that rate hikes will eventually come suggests that we'll see a few hikes before the end of the year," said CIBC chief economist Avery Shenfeld.   Continued...

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