OTTAWA (Reuters) - Canada’s central bank was unwavering on Tuesday in its view that it may need to hike interest rates, not cut them, even as the country’s economy shows signs of slowing and uncertainty over the U.S. fiscal cliff shakes North American economic confidence.
Bank of Canada Governor Mark Carney - who will become head of the Bank of England in July - has held the overnight lending rate at 1 percent since September of 2010, the longest period of bank inactivity on rates since the early 1950s.
But that didn’t stop the bank from repeating the wording for its rate outlook that it used in October to signal it is leaning towards tightening monetary policy. It is the only central bank in the Group of Seven wealthy nations to have that bias.
“Over time, some modest withdrawal of monetary policy stimulus will likely be required, consistent with achieving the 2 percent inflation target,” the bank said in a statement, using language identical to that it employed in its October 23 rate announcement.
The bank began talking about rate hikes starting in April of this year and in October Carney tweaked that message slightly to say a move was “less imminent”, although the next move on rates would still be an upward one. Market players don’t expect a hike until the fourth quarter of 2013.
There were no explicit signs in Tuesday’s statement that the bank was preparing to turn dovish, at least for now.
“The key is that they’re keeping word for word to the bias that they introduced in October,” said Doug Porter, deputy chief economist at BMO Capital Markets.
“I think the real test for the bank and markets will be whether we do get a reversal in the economic data in the weeks ahead, or it continues to deteriorate, and I think that’s going to determine whether they stick to that bias in early 2013,” he said.
The bank acknowledged Canada’s disappointing third-quarter economic growth of 0.6 percent, annualized, although it said the slowdown was partly due to temporary disruptions in the energy sector.
“Although underlying momentum appears slightly softer than previously anticipated, the pace of economic growth is expected to pick up through 2013,” it said.
The Canadian dollar extended gains against the U.S. dollar after the bank’s statement to a session high of C$0.9926 vs. the U.S. dollar, or $1.0075, up from Monday’s finish of C$0.9949, or $1.0051.
Yields on overnight index swaps, which trade based on expectations for the policy rate, showed traders scaled back their bets on a rate cut after the statement maintained the bank’s hawkish language.
Camilla Sutton, chief currency strategist at Scotiabank, said the Canadian dollar had been held back this week by the perceived risk of a policy shift by the central bank.
“Now that it’s passed, this type of steady-as-she-goes statement opens up the potential for Canadian dollar strength,” she said.
The bank was cautiously upbeat on developments in the overheated housing market, saying housing activity is beginning to cool from record high levels and growth in household credit has slowed. However, it is too early to say whether the trend will be sustained, it warned, noting that personal debt continues to rise.
Inflation, which analysts expect to be below the bank’s forecasts in the fourth quarter, is “broadly in line” with the bank’s October projections, it said. It sees both total and core inflation returning to the bank’s 2 percent target “over the course of the next 12 months”. In October, it said core inflation would reach the target in mid-2013 and total inflation would reach it at the end of next year.
October inflation was 1.3 percent, well below the bank’s projection for average inflation of 1.6 percent in the fourth quarter.
The bank also noted that the gradual growth in the United States, Canada’s top trade partner, was being held back by uncertainty over the so-called fiscal cliff, a set of tax hikes and spending cuts that will automatically kick in next year and set the economy back unless a gridlocked Congress negotiates an alternative deal with the White House.
The overall global economy has not delivered any surprises since the bank’s October projections, with Europe remaining in recession and Chinese growth stabilizing, the bank said.
Additional reporting by Claire Sibonney, Alastair Sharp and Allison Martell; Editing by Chizu Nomiyama; and Peter Galloway