December 7, 2016 / 3:26 PM / in 10 months

UPDATE 2-Bank of Canada holds rates steady, citing economic slack

(Recasts with rate cut off the table, adds economist comment)

By Andrea Hopkins and Leah Schnurr

OTTAWA, Dec 7 (Reuters) - - The Bank of Canada pointed to a “significant” amount of slack in the Canadian economy as it held interest rates steady on Wednesday, but also used language suggesting a rate cut is off the table as global growth picks up.

Sounding less dovish than several analysts had expected, the central bank trod a fine line in moving away from a possible interest rate cut even as it pointed to all the reasons why Canada would not follow the U.S. Federal Reserve in raising rates.

The central bank’s decision to leave rates unchanged was widely expected, and sets the stage for a divergence in policy from that of the Fed, which is expected to hike rates later this month.

Citing a positive for every negative it outlined, the bank moved away from a more pessimistic tone it set in October, when Governor Stephen Poloz said policymakers had actively considered cutting rates.

“It was a little less dovish than we would’ve expected given how much tighter financial conditions have become overall,” said Royce Mendes, senior economist at CIBC Capital Markets.

The bank noted the rapid backup in global bond yields since the U.S. election on Nov. 8, which it said partly reflected market anticipation that spending by the Trump administration could drive rapid growth in an economy that is already near full capacity. Canadian yields have risen significantly alongside, the bank noted.

That increases borrowing costs for businesses and consumers and works in opposition to the bank’s attempt to keep rates low enough to stimulate growth - “something they’re not pleased with at moment given that Canada still has an output gap that needs to be closed,” Mendes said.

Canada has struggled to regain momentum amid slumping oil prices, with a weaker currency not helping exports as much as policymakers had hoped and businesses too uncertain to invest enough to boost growth.

The bank said more moderate growth is expected after a rebound in the third quarter, and said business investment and non-energy goods exports continue to disappoint. The bank also suggested recent job growth masks weakness in the economy.

“There have been ongoing gains in employment, but a significant amount of economic slack remains in Canada, in contrast to the United States,” the bank said.

While global economic conditions have strengthened, the bank said uncertainty, which has been undermining business confidence and dampening investment in Canada’s major trading partners, “remains undiminished.” (Reporting by Leah Schnurr and Andrea Hopkins; Editing by Will Dunham and Jonathan Oatis)

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