March 2, 2010 / 2:23 PM / in 8 years

Bank of Canada keeps rates low despite robust growth

OTTAWA (Reuters) - The Bank of Canada held its key interest rate at a record low on Tuesday, but signaled it is getting closer to raising rates, though promising again not to do so before the third quarter.

The central bank reiterated the commitment it made in April 2008 to keep its target overnight rate at a record low 0.25 percent until the end of the second quarter, conditional on inflation staying on track.

In its policy statement, however, it acknowledged stronger-than-expected economic growth and inflation and it removed a reference to downside risks to its inflation outlook that had been present in previous statements -- all suggesting a slightly more hawkish stance.

“This is a statement that is a little stronger than in the past,” said Eric Lascelles, chief economics and rates strategist at TD Securities.

“But it looks like they are reluctant to change their view and I think you can still conclude that we’re not going to get any hikes in the next little while,” he said.

The Canadian dollar firmed following the rate announcement, rising to a high of C$1.0315, or 96.95 U.S. cents, from about C$1.0366, or 96.47 U.S. cents, before the central bank statement.

Yields on overnight index swaps, which trade based on expectations for the key policy rate, edged lower, showing the market saw tightening as slightly less likely than before the statement..

Nine of 12 primary securities dealers surveyed by Reuters last week said they expected no rate increases before July, with one seeing the first hike in April and two expecting a hike in June.

The bank suggested it was not prepared to raise rates early because of slack in the economy, continuing strength in Canada’s currency, and weak U.S. demand for Canadian exports.

It noted evidence of strength in the economy, with annualized fourth-quarter growth of 5 percent and core inflation hitting 2 percent in January -- but also repeated language suggesting the recovery is not fully entrenched.

“Core inflation has been slightly firmer than projected, the result of both transitory factors and the higher level of economic activity,” it said.

Strong domestic demand will continue to pressure prices but there will also be downward pressure from slowing wage growth and overall excess supply, the bank said.

With regards to economic growth, it repeated that the recovery is driven by government and central bank stimulus measures, increased confidence, improved financial conditions, global growth and better terms of trade.

Contrary to expectations, it did not water down its language on the strong Canadian dollar hampering growth.

“At the same time, the persistent strength of the Canadian dollar and the low absolute level of U.S. demand continue to act as significant drags on economic activity in Canada,” it said.

The bank will likely provide more clues about the timing of eventual rate hikes at its April 20 rate announcement and April 22 monetary policy report.

“Right now I think it’s setting the stage to an upgrade to their GDP forecast when we get their next round of official projections in April,” said Jonathan Basile, economist at Credit Suisse.

“The third quarter is still where we anticipate the first rate hike,” he said.

That might depend on what the United States does with rates, argued Martin Hubbes, chief investment officer at AGF Investments.

“I don’t think they’re going to move until they get more clarity about what’s going on in the U.S. ... and obviously a rate increase in Canada would drive our currency higher versus the U.S. dollar, which is probably not something they want today,” Hubbes said.

“That would be difficult for our economy to absorb at the present time.”

Additional reporting by Howaida Sorour, Ka Ya Ng, Claire Sibonney and John McCrank; editing by Peter Galloway

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