Bank of Canada holds rates unchanged

The Bank of Canada held its overnight rate target steady Wednesday, a non-move widely expected by the markets, and indicated it expects to remain on hold for the foreseeable future.

The central bank maintained its benchmark rate at 4.25 per cent. It was the second straight rate announcement in which the bank held the rate steady, following seven consecutive 25-basis-point increases that began in September 2005. (A basis point is one-hundredth of a percentage point.)

“Looking forward, the bank continues to expect the Canadian economy to operate at about its production potential, with total CPI inflation returning to the 2-per-cent inflation target in the second half of 2007,” the bank said in its statement accompanying the rate announcement. “In line with this outlook, the current level of the target for the overnight rate is judged at this time to be consistent with achieving the inflation target over the medium term.”

Analysts took the rate-setting statement as evidence that the bank will probably keep rates steady for at least the rest of this year.

“The Bank of Canada remains sidelined, and continues to display a degree of comfort with that position,” said Stewart Hall, market strategist at HSBC Securities Canada Inc. in Toronto.

The Bank of Canada said the underlying trends in the Canadian economy remain in line with “the broad thrust” of its output and inflation projections contained in its July monetary policy report update, which was issued on July 13, two days after the previous rate announcement. It said Canadian economic growth in the second quarter was “somewhat below the bank's expectations,” while consumer price index (CPI) inflation was “slightly higher” than expected.

It added that global economic growth remains “solid,” although U.S. growth has moderated.

The central bank said the key downside risk for the Canadian economy lies south of the border, where the housing market has recently developed some cracks that threaten to slow consumer demand and, by extension, demand for Canadian exports. This echoes a warning made by Bank of Canada Governor David Dodge in July, when the bank issued the monetary policy update. It said the key upside risks involve the momentum of domestic housing prices and household spending.

The bank said both the upside and downside risks “appear to be a little greater than they were in July,” but overall, “risks are roughly balanced.”

The Bank of Canada adjusts its interest-rate policy eight times a year. Wednesday's announcement was the sixth of this year. The next rate announcement is scheduled for Oct. 17. It will issue its next monetary policy report on Oct. 19.

While analysts agreed that the statement was largely in line with the bank's previously stated stand-pat position on rates, some felt it was less dovish than they had anticipated. Some noted, for instance, that the bank is no longer saying that the balance of risks in its outlook is tilted slightly to the downside, and no longer mentions the high Canadian dollar as a downside risk factor.

However, others noted that the bank is now talking about the Canadian economy operating at about its production potential, rather than slightly above potential as it said in the previous rate announcement in July. Some took this as evidence that output expectations are easing as export demand is poised to slow, and argued that rates could head lower before they head higher.

“Although the Canadian economy is in fundamentally better health than its U.S. counterpart – which should allow it to outperform on the growth front – the economic slowdown that is materializing in the U.S. will inevitably spill over to this side of the border,” said Marc Lévesque, chief North American forex and fixed-income strategist at TD Securities. “As a result, we are expecting several quarters of below-potential growth — and the next Bank of Canada move not to be a hike, but a cut in 2007.”

(prepared by David Parkinson/Globe & Mail)