Interest rates to hold despite weakening economy

The Canadian economy appears to be weakening more than expected, the Bank of Canada admitted Tuesday, but indicated it’s not yet weak enough to warrant an interest rate cut.

“Global growth has been strong, commodity prices have remained h i g h , a n d e m p l oy m e n t g row t h in Canada and the United States has been sustained,” it said in announcing it will keep its trend-setting target for overnight lending rates at 4. 25 per cent.

While some recent indicators suggest growth in Canada and the U.S. may be a “little weaker” than expected, inflation has been in line with expectations, it said.

Stronger than expected increases in consumer spending and housing prices pose the greatest inflation risk, while a sharper than expected slowdown in the U.S. poses the greatest risk to the economy, it said.

However, at this point in time those risks are roughly balanced, it added, in explaining its decision to leave rates unchanged,

Still, some analysts noted the central bank has dropped its previous warning that the economy is operating above its capacity.

“ The bank could obviously no longer make this statement in light of the weak growth in the third quarter and the anticipation of another lacklustre fourth quarter,” National Bank of Canada economists said in an analysis.

“This is an important development as it is the first step for opening the door to . . . rate cuts,” they said, adding the most likely scenario is that the bank will begin cutting rates early in the spring.

“While futures markets continue to price in about an 85 per cent probability of a Bank of Canada rate cut by June 2007 . . . we continue to think that if growth remains roughly on track with the Bank of Canada forecast and inflation tracks above the two per cent target, as we expect, then it will likely need to warn that further rate hikes may be needed . . . , ” s a i d Te d Carmichael, economist at J.P. Morgan.

The Canadian dollar, after enjoying a brief one-day rally at the start of this week , slipped back to the mid - 87 cents US level following the bank rate announcement.

However, the dip, which came in the wake of news of surprising strength in the non-manufacturing side of the U.S. economy was more a reflection of the rebound in the U.S. greenback than weakness in the loonie.

While many economists and money markets expect the central bank will begin cutting rates sometime next year, there are those who disagree and expect it will keep rates steady throughout 2007, giving Canadians a rare extended period of rate stability.

“We continue to expect rates to remain stable through 2007,” said Bank of Montreal economist Sal Guatieri.

And some warned the next move by the Bank of Canada will in fact be to raise rates further, not cut them.

(prepared by Eric Beauchesne/Vancouver Sun)