July 16, 2008 / 12:10 AM / 9 years ago

Bank of Canada sees inflation spiking, rates steady

OTTAWA (Reuters) - Canadian inflation could spike above 4 percent for the first time since 2003 next year, double the central bank target rate, but the Bank of Canada looks unlikely to respond with rate hikes at any time soon.

<p>Bank of Canada Governor Mark Carney leaves his office for a news conference upon the release of the Monetary Policy Report in Ottawa in this April 24, 2008 file photo. REUTERS/Chris Wattie</p>

Meeting unanimous market expectations, the Bank of Canada on Tuesday held its overnight lending rate at 3 percent, citing risks from a weak U.S. economy and financial market turmoil.

It backed away from a hawkish tone of just one month ago and signaled it may stand pat on rates for the rest of the year.

“The comments of the bank are in my view quite a bit more neutral than the previous time in June, so I think the bank is really moving on to not changing rates for quite a while,” said Carlos Leitao, chief economist at Laurentian Bank of Canada.

Markets initially pushed the Canadian dollar a notch lower, although the currency later rose to near a six-week high around US$1.002, or 99.77 Canadian cents to the U.S. dollar, as gloomy Fed comments drove the U.S. dollar lower.

In a statement announcing its interest rate decision, the Bank of Canada flagged higher inflation as the one development that has taken it by surprise.

But it made no hint of a future rate hike to rein in prices and suggested that the U.S. slowdown and the market turmoil made a future rate cut as likely as a future rate rise.

“Against this backdrop, the bank judges that the current level of the target for the overnight rate remains appropriate,” it said.

“The bank will continue to monitor carefully the evolution of risks, together with economic and financial developments in the Canadian and global economies, and set monetary policy consistent with achieving the inflation target over the medium term.”

The Bank of Canada targets inflation in a range between 1 percent and 3 percent. It next sets rates in seven weeks, on September 3.

In June, the bank surprised markets by keeping rates on hold instead of lowering them, halting a rate-cut cycle that had lopped 150 basis points off its key rate since December.

Soaring oil prices were behind that move and Governor Mark Carney followed up with a hawkish speech in which he promised a “relentless focus on inflation.”

CALLS FOR NO MOVE

But analysts said the language on the “balance of risks” in Tuesday’s statement was decidedly more neutral.

“Our call is they don’t move until next year and I think I am comfortable with that call based on this,” said Doug Porter, deputy chief economist at BMO Capital Markets.

U.S. markets have also shifted away from rate hike predictions as high oil prices and the deepening credit crunch crimp consumer and investor confidence. Canada’s rate remains 1 percentage point above the 2 percent U.S. federal funds rate.

The Bank of Canada said inflation should spike sharply above its target range and peak at above 4 percent in the first quarter of 2009, assuming energy prices follow futures prices. That would bring inflation to its highest since March 2003.

But core inflation, which strips out volatile items like gasoline and food, will average just 1.5 percent through the third quarter. The bank sees both measures of inflation converging at 2 percent in the second half of 2009.

The bank cut its forecast for 2008 economic growth to 1 percent from 1.4 percent, and nudged its 2009 forecast down to 2.3 percent from 2.4 percent. It left its 2010 growth outlook unchanged at 3.3 percent.

The bank will release more details on its revised outlook on Thursday at 10:30 a.m.

Additional reporting by Frank Pingue in Toronto; editing by Janet Guttsman

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