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Bank of Canada holds the line on rates

Bank of Canada holds the line on rates

HEATHER SCOFFIELD

Wednesday, September 03, 2008

OTTAWA — The Bank of Canada is keeping its key interest rate on hold, even though inflationary pressure has abated in Canada, and growth has slowed to a stop.

The central bank announced Wednesday that the overnight rate will remain at three per cent, and gave few hints about which direction its next move might be.

“The bank judges that the current level of the target for the overnight rate remains appropriately accommodative,” the bank said.

Economists had widely expected the bank to keep rates unchanged, although some had also expected the bank to suggest that its next move would be a rate cut in order to stimulate Canada's flagging economy.

The bank omitted its traditional assessment of the risks facing the bank's forecast – an assessment that is usually closely watched to determine whether the bank is leaning in the direction of future rate cuts or hikes.

Instead, the bank's one-page statement focused on the reversal in commodity prices since the beginning of July. Then, oil was trading above $140 (U.S.) a barrel, and has since declined steeply to close on Tuesday at $109.71 – driven lower by sagging global demand, the bank said.

The slide has meant that the central bank's earlier expectations that the inflation rate would soar to above four per cent by the end of this year will not pan out, the statement said, although the bank said it expects commodity prices to remain volatile because of tight inventories.

At the same time, lower oil prices have also meant that the Canadian dollar is much weaker than a couple of months ago. Normally, a weaker Canadian dollar would boost Canadian exports, but this time, it comes just as the world economy is losing steam, the bank noted.

“The weaker global growth and the decline of the Canadian dollar will have opposing effects on the demand for Canadian goods and services,” the bank stated.

The Canadian dollar closed at 93.58 cents (U.S.) on Tuesday, after trading just below parity for months.

The bank did not express any concern for Canada's stagnant economy, which contracted in the first quarter and barely expanded in the second quarter. Domestic demand has softened, but remains fairly strong, the bank said.

“Overall, the level of economic activity is slightly lower than expected in July but still close to the economy's production capacity.”

Total inflation, which has surged above three per cent recently, has been affected by temporary factors and should move back to the bank's two per cent target by this time next year, the bank said.

Still, the bank warned that the heightened inflation risk that gripped central bankers a couple of months ago and prompted the Bank of Canada to suddenly stop its aggressive rate cuts this summer still exists.

“Global inflationary pressures remain elevated, with potential implications for import prices and the dynamics of inflation in Canada,” the bank said.

Around the world, rising food and commodity prices have driven up inflation over the past few months, especially in emerging markets, but also in developed economies, albeit to a lesser extent.

In the United States, economic growth and the turbulence in global financial markets are unfolding as the bank expected, the statement said. The bank has projected 1.6 per cent growth in the United States this year, despite continuing turmoil in the financial sector and a collapse of the housing market.

Still, there's a risk that the negative feedback loop between the U.S. economy and tighter credit conditions will worsen, and hamper the expected revival of the U.S. economy in 2009, the bank suggested.

The Bank of Canada's next rate announcement is on Oct. 21 – a week after the widely-anticipated date of the federal election. With interest rates on hold, and the bank giving no obvious indication about its next move, Governor Mark Carney has likely removed himself as a factor in an election campaign that will no doubt be dominated by debate on how to manage the flagging economy.

© The Globe and Mail
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