Bank of Canada holds firm on interest rates

Bay Street stocks suffered another triple-digit loss but the dollar rebounded after the Bank of Canada decided against cutting interest rates on Wednesday despite admitting that the economy is weaker than it expected and the projected spike in inflation will be less than it feared.

"There's really no suggestion the bank is paving the road towards lower rates," BMO Capital Markets economist Douglas Porter said after the central bank kept its trend-setting target rate steady at three per cent, as expected.

"It seems that it's going to take much more severe weakening to get the bank talking rate cuts," Porter said.

"In a nutshell, they are on hold unless the floor drops out from beneath the economy."

The prospect that interest rates won't be cut, combined with a further slide in oil prices, weighed on the benchmark TSX, which fell more than 160 points, following a more than 400-point plunge Tuesday.

The currency, however, benefitted from the central bank's tough anti-inflation stance, which more than offset the impact of weaker prices for oil and most other commodities. The dollar closed at 94.25 cents US, up from 93.58 cents US Tuesday.

The bank justified its decision to keep rates steady saying that "global inflationary pressures remain elevated" despite the plunge in oil prices resulting from the worldwide economic slowdown.

It also indicated that the recent slide in the Canadian dollar will add to import prices, adding to the risk of higher inflation. However, it said the fall in oil prices also suggests that inflation will not surge to the more than four per cent it projected last spring, reiterating that it expects inflation will retreat to its two per cent target in the second half of 2009.

In terms of economic growth, it said "economic activity is slightly lower than expected in July but still close to the economy's production capacity."

While the economy managed to narrowly skirt a recession, defined as back-to-back quarterly contractions, output is still down so far this year. And the Organization for Economic Cooperation and Development this week cut its forecast for growth this year to just 0.8 per cent, less than the roughly one per cent the Bank of Canada and Finance Department are projecting.

The OECD upwardly revised its projection for U.S. growth to 1.8 per cent, more than double its projection for Canada's economy.

However, National Bank of Canada said that the Bank of Canada was right to keep rates steady for now.

"In our opinion, the Bank of Canada did the right thing," said National Bank economist Paul-Andre Pinsonnault, noting that it has already injected 1.5 percentage points of interest rate relief into the economy over the past year.

Not all analysts agree, however.

"The need for economic stimulus has become more pressing," charged United Steelworkers economist Erin Weir, noting that 95,000 private-sector jobs disappeared last month, the greatest loss since the 1990s recession.

"Many factors could help explain why Canada is now underperforming the US, but one may be that the Bank of Canada has provided less than half as much economic stimulus as the American Federal Reserve," he added, noting that the U.S. Federal Reserve has cut rates by 3.25 percentage points.

There was more surprising evidence Wednesday of unexpected strength in U.S. manufacturing.

"The U.S. factory orders report for July revealed small positive surprises for nearly all the shipments, inventories, orders, and equipment figures from the last durable goods report, hence exacerbating the pattern of remarkable resilience in the durable figures through the month," Action Economics, an online think-tank, noted.

While some analysts still suspect the central bank may cut rates on Oct. 21, the next preset date for any rate adjustment and following an expected mid-October election, others suspect there will be no further change in rates this year

"Going forward, it is becoming clear the Bank of Canada would have to see either significantly weaker-than-expected labour and/or housing markets or renewed stresses in Canadian financial markets conditions to consider easing further," said TD economist Pascal Gauthier.

"Short of that, we look for the Bank of Canada to stay on hold for the balance of the year."

(prepared by Eric Beauchesne/Vancouver Sun)