Oct. 20 (Bloomberg) -- The Bank of Canada will probably keep its key interest rate at a record low today and say that the Canadian dollar’s rise toward parity with the U.S. currency threatens an economic recovery.

The target rate for overnight loans between commercial banks will stay at 0.25 percent in a decision due at 9 a.m. New York time, said all 26 economists surveyed by Bloomberg. Money markets have priced in no chance of a rate increase. The bank will also probably repeat a commitment to keep the rate unchanged through June 2010 unless the inflation outlook shifts, economists said.

The Canadian currency has gained as much as 5.1 percent since the bank’s last decision Sept. 10, when policy makers said its “persistent” strength could delay the return of inflation to the 2 percent target. Governor Mark Carneysaid Sept. 28 that the stronger currency reflects a rebound in commodity prices and “a more generalized weakening of the U.S. dollar.”

“The onus is on the Bank of Canada sending a signal that it does not plan on hiking rates in the near term,” said Eric Lascelles, chief economics and rates strategist at TD Securities Inc. in Toronto, a unit of Canada’s second-biggest bank. “That probably will take a little bit of the wind out of the currency’s sails,” he said, adding the effect is likely to be only temporary.

The Canadian dollar traded at C$1.03 per U.S. dollar late yesterday, leaving it 18 percent stronger than at the start of this year, and about 10 percent above the exchange rate assumed in the central bank’s July economic forecast. The appreciation makes the country’s shipments of automobiles, lumber and metals to the U.S. less competitive and restrains inflation by making imports cheaper.

Weaker Inflation

Consumer prices have been weaker than the bank projected in July, with an average annual decrease of 0.9 percent in the third quarter, compared with the bank’s July forecast for prices to fall 0.7 percent.

“The Bank of Canada has little to fear from inflation anytime soon,” said Stewart Hall, an economist at HSBC Securities in Toronto.

The currency last traded at parity with U.S. dollar in July 2008, and rising commodity prices and a general U.S. dollar decline may take it to a record high, David Rosenberg, chief economist and strategist at Toronto-based wealth manager Gluskin Sheff & Associates Inc., said in an interview in Bloomberg’s Toronto office. The currency closed at a record 92.03 Canadian cents per U.S. dollar on Nov. 6, 2007.

‘Much More Painful’

A Canadian dollar trading above parity may be “much more painful” to the economy than two years ago, said Doug Porter, deputy chief economist with BMO Capital Markets in Toronto. “Last time we were at parity, oil prices were closer to $100 a barrel and commodity prices in general were a lot stronger and U.S. demand was a lot healthier,” Porter said.

Still, the central bank will probably just stick to its pledge to keep rates low instead of driving down the currency by selling Canadian dollars in exchange markets or doing so-called quantitative easing, Porter said. “It probably increases the chance the Bank of Canada will stay on hold until the middle part of 2010,” he said.

Canada reported an unexpected drop in the unemployment rate for September as employers added 30,600 jobs, and home resales and prices have also increased in the past few months. Prices for commodities that make up half the country’s exports have also risen 15 percent so far this year, after last year’s 31 percent plunge.

Australia’s Rate

Investors increased bets that the central bank will raise borrowing costs within the next year after Australia became the first Group of 20 country to raise interest rates since the global crisis began. Bank of Canada Senior Deputy Governor Paul Jenkins stressed that Australia is more tied to China, where orders are stronger, while Canada’s main customer is the U.S.

“One shouldn’t draw a very tight comparison between what’s happening in Australia and Canada,” Jenkins said.

Prime Minister Stephen Harper has called the economic recovery “fragile” and echoed Carney’s comments about the currency, while fending off Liberal Leader Michael Ignatieff’s effort to force an early election. Harper has said an election now would threaten government stimulus spending.

The central bank may increase its prediction for growth in the second half of this year. The bank has said there has been progress in reviving automobile production and reducing inventories of unsold goods. Jenkins said Oct. 8 that “some of this stronger growth reflects the effects of temporary factors, such as the impact of the U.S. ‘cash-for-clunkers’ program on Canadian automotive production.”

In July, the Bank of Canada said the economy would grow at a 1.3 percent annualized third-quarter pace, ending a recession that began at the end of last year, and forecast fourth-quarter growth of 3 percent.

“We have seen some recent recovery,” Ian Cameron, chief financial officer of methanol producer Methanex Corp., said last month on an earnings call. “Demand in Asia has increased and we are seeing some modest signs of recovery in demand also in North America and Europe just recently.”

To contact the reporters on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net; Theophilos Argitis at targitis@bloomberg.net.

Last Updated: October 20, 2009 00:01 EDT