Rates might stay low even at capacity: BOC

Wed Jul 20, 2011 10:33am EDT
 
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OTTAWA (Reuters) - The Bank of Canada signaled on Wednesday it might keep interest rates below their normal long-run level even after the Canadian economy is back to full capacity, and its expected rate hikes would be gradual.

The central bank took pains to say that as the economy approaches full capacity in mid-2012 and inflation converges on the 2 percent target, markets should not assume interest rates will necessarily be back to their normal level by then.

"The key message is that, in general, the policy rate can deviate from its long-run level even if inflation is at target and output is at potential," it said in a separate article in its quarterly Monetary Policy Report.

"In the context of a projection for inflation, this implies that the policy rate can return to its long-run level after inflation is projected to reach the 2 percent target and output is projected to reach its potential."

The bank's overnight rate is currently at 1.0 percent, which is still highly stimulative. The bank does not say what it considers to be a normal long-run or neutral rate.

Some market players have speculated that in order to reach what is considered a neutral rate -- which would have to be well above the inflation rate -- the bank would have to hike rates rapidly ahead of mid-2012.

The bank said some monetary stimulus would have to be withdrawn as the expansion continues and excess supply is gradually absorbed. It repeated language from its April report that its projection includes "a gradual reduction in monetary stimulus over the projection horizon."

(Reporting by Randall Palmer; Editing by Louise Egan)