January 20, 2016 / 3:06 PM / 2 years ago

Bank of Canada holds rates steady as currency worries weigh

Bank of Canada Governor Stephen Poloz speaks during a news conference in Ottawa, Canada October 21, 2015. REUTERS/Chris Wattie

OTTAWA (Reuters) - The Bank of Canada decided not to cut interest rates on Wednesday but admitted it was not an easy call, as concern about a rapid decline in the currency clashed with an economic slump.

With a rate cut certain to drag the Canadian dollar lower, the central bank held rates steady, despite calls by some for action to stimulate an economy sideswiped by a prolonged drop in the price of oil and other commodities.

“It is fair to say ... that our deliberations began with a bias toward further monetary easing,” Governor Stephen Poloz said in a rare glimpse into the inner workings of the central bank’s Governing Council.

While some analysts called it a missed opportunity to help the economy, the rate decision helped the battered Canadian dollar CAD=D4 rebound from its lowest in nearly 13-years - at least temporarily. [CAD/]

The Bank of Canada held its main policy rate at 0.5 percent, where it has been since its last rate cut in July. But it lowered its gross domestic product (GDP) forecast for 2016 to 1.4 percent from 2.0 percent and nudged expected 2017 growth down to 2.4 percent from 2.5 percent.

The central bank acknowledged falling commodity prices represented a “setback” for the resource-rich Canadian economy and estimated that fourth-quarter growth had stalled.

The Canadian economy endured a shallow recession in the first half of 2015 and has been trying to avoid a so-called “double-dip” recession that would come with two quarters of negative growth.

Poloz said the weak currency and stronger U.S. demand will help spur an economic rebound and noted it had not incorporated in its forecasts the “positive impact” of fiscal measures promised by Prime Minister Justin Trudeau, who took office in November.

The Liberals have promised to run deficits for three years to boost infrastructure spending.

“They are passing the buck to the federal authorities to boost spending,” said David Watt, chief economist at HSBC Bank Canada. “So now the monetary policy play becomes a vote on fiscal policy.”

In the days leading up to the bank’s decision, markets had priced in nearly a two-thirds chance of a rate cut as oil slid relentlessly. But by Tuesday some were saying the bank should hold its fire, rather than risk further weakness in the Canadian dollar, also known as the loonie.

Even exporters complained the currency’s speedy fall had cut into their margins as the price of imported inputs climbed.

CURRENCY CONCERNS

The bank said the economy was in a process of reorientation to non-resource activity, helped by stronger U.S. demand, the lower Canadian dollar, and accommodative monetary and financial conditions.

It said inflation was evolving broadly as expected, with total inflation seen rising to about 2 percent by early 2017.

Its base-case projection showed the time period when excess capacity will be eliminated being delayed until the end of 2017 from its October estimate of mid-2017.

“All things considered, therefore, the risks to the profile for inflation are roughly balanced,” the Bank of Canada said.

It also noted that financial vulnerabilities continued to edge higher as anticipated, but it foresaw the housing market and household indebtedness stabilizing as the economy strengthens and household borrowing rates begin to normalize.

The bank highlighted the risk that a large and fast depreciation in the loonie could boost inflation expectations.

The Canadian dollar CAD=D4 has already slid below 72 U.S. cents, or C$1.3889 to the U.S. dollar, which is the rate used in Wednesday’s Monetary Policy Report. That gives more economic stimulus beyond what is built into the assumptions.

However, oil has slid further below the bank’s assumptions.

With additional writing by Andrea Hopkins; Editing by Paul Simao and Chizu Nomiyama

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