Central Bank holds course

The Canadian dollar soared back above parity with the U.S. currency yesterday and the stock market plunged after the Bank of Canada warned that inflation will rise a lot more than expected, even as economic growth grinds slower.

It was a warning that was echoed south of the border by Federal Reserve Board chairman Ben Bernanke, who told the U.S. Senate banking committee that there are "significant downside risks to the outlook for growth," and that "upside risks to the inflation outlook have intensified."

The outlook for weaker-than-expected growth was underscored by news that for the first time this decade home prices in Canada have fallen, with the average price of a home in June being 0.4 per cent lower than a year earlier.

Adding to the gloom was an announcement by struggling General Motors of further job cuts in its North American operations.

The Bank of Canada -- which kept its trend-setting interest rate steady yesterday, as widely expected -- cautioned that there are "significant risks" that inflation could be even higher than the projected four per cent or that growth could be even more anemic than the anticipated one per cent.

Inflation will briefly rise above four per cent by early next year, more than double the central bank's two per cent target, while growth this year will be only one per cent, down from the 1.4 expected only three months ago, it said in announcing that its target rate will be kept at three per cent.

"Three major developments are affecting the Canadian economy: the protracted weakness in the U.S. economy, ongoing turbulence in global financial markets and sharp increases in many commodity prices," it said.

"The first two developments are evolving roughly in line with expectations," it said. "However, commodity prices are continuing to outstrip earlier expectations. This has . . . altered the outlook for global and domestic inflation."

The report comes a week after Prime Minister Stephen Harper said that inflation in Canada is not a major concern.

The Canadian dollar, meanwhile, responded to the bank's hawkish warning about inflation, which suggests its next move will be to raise rates, by rising back to parity with the U.S. dollar for the first time in six weeks. It later eased back to 99.94 cents US at midday, up from Monday's close of 99.48.

The Toronto Stock Exchange's benchmark index plunged yesterday, losing more than 400 points by midday.

The Bank of Canada came under immediate fire from a senior labour economist for its decision.

"It should have cut interest rates because Canada's slowing economy and overvalued currency are more serious problems than the spectre of inflation," said Erin Weir, economist with United Steelworkers, noting that 39,000 full-time jobs disappeared last month and that the economy contracted in the first quarter of this year.

However, BMO Capital Markets economist Douglas Porter said the bank made the right decision.

"While the bank is warning a bit more forcefully on the inflation risks, the reality of the global credit crunch and dicey outlook for the U.S. economy will keep them on hold for some time yet," he said.

(prepared by Eric Beauchesne/Vancouver Province)