October 25, 2011 / 1:18 PM / in 6 years

Bank of Canada holds rates

<p>A woman walks past the Bank of Canada building in Ottawa September 7, 2011. REUTERS/Chris Wattie</p>

OTTAWA (Reuters) - The Bank of Canada took the prospect of interest rate hikes off the table on Tuesday with downgraded forecasts that showed some of the gloss coming off an economic recovery touted as the strongest in the G7.

The central bank held its key interest rate steady at an ultra-low 1 percent, as expected, but said the European debt crisis and weakness in its top trade partner, the United States meant the outlook for the Canadian economy had weakened.

It omitted language used in every rate announcement since May on the need to withdraw monetary stimulus, saying simply “there is considerable monetary policy stimulus in place.”

The change in outlook was “pretty powerful” and suggests the bank will be on hold for a very long time, said Michael Gregory, senior economist at BMO Capital Markets.

“A lot of talk about the global economy, in fact if I‘m just adding up the words here, more talk about the global economy than the domestic economy, which itself perhaps sums up where the net risks to Canada really lie,” he said.

The dovish tone means investors have increased the chance of a rate cut in the coming year, although the bank made no suggestion of easing. The Canadian dollar hit a session low.

Bank of Canada Governor Mark Carney said earlier this month the bank won’t be “trigger happy,” but has room to cut rates if needed.

A weaker global economy, including a likely brief recession in the euro area, prompted the bank to cut its Canadian growth forecasts to 2.1 percent from 2.8 percent for this year and to 1.9 percent from 2.6 percent for 2012.

It sees inflation returning to its 2 percent target 18 months later than previously expected, at the end of 2013. Inflation was an above-target 3.2 percent in September, but the bank sees the rate declining to 1 percent by the middle of next year before bouncing back.

“The weaker economic outlook implies greater and more persistent economic slack than previously anticipated, with the Canadian economy now expected to return to full capacity by the end of 2013,” the bank said. It previously expected full capacity by mid-2012.

The bank raised its 2013 growth projection to 2.9 percent growth from 2.1 percent previously.

Canada’s central bank was the first in the Group of Seven rich nations to raise interest rates after the global financial crisis, lifting the rate three times in mid-2010. It has been on hold since then, and nobody expected a move on Tuesday.

A Reuters poll released October 18 predicted a next rate hike in the third quarter of next year.

But overnight index swaps, which are based on expectations for the rate, showed traders now think a rate cut is more likely than it was before.

The Canadian dollar weakened to C$1.0060 to the U.S. dollar, or 99.40 U.S. cents, below the pre-announcement level near Monday’s North American session close at C$1.0031 to the U.S. dollar, or 99.69 U.S. cents.

The yield on the two-year Canadian government bond, which is especially sensitive to Bank of Canada interest rate moves, fell to 1.08 percent from 1.11 percent just before the announcement.

Additional reporting by Claire Sibonney, Andrea Hopkins and Jon Cook in Toronto; editing by Janet Guttsman

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