Bank of Canada Keeps Key Lending Rate at 1% on Weak Exports, Global Risks

The Bank of Canada kept its benchmark interest rate at 1 percent for a second consecutive time, and said it will remain careful about future increases as falling exports and Europe’s sovereign debt crisis hinder the economic recovery.

Governor Mark Carney’s decision was anticipated by all 24 economists surveyed by Bloomberg News, after the bank paused Oct. 19 following three rate increases earlier this year. The decision “leaves considerable monetary stimulus in place” at a time of “significant excess supply in Canada,” the bank said.

Canada’s economy “appears slightly weaker” than expected in the second half of this year and exports “continued to exert a significant drag on growth,” the bank said. The Canadian dollar’s 29 percent gain against the U.S. dollar since March 2009 is curbing orders for companies such as forest-products firm Tembec Inc. and encouraging imports of equipment to boost productivity.

“They put a little bit more emphasis on some of the negatives that have evolved over the past six weeks and downplayed some of the positives or ignored them” said Doug Porter, deputy chief economist with BMO Capital Markets in Toronto. “It’s fairly clear cut that we need a better recovery in the U.S. before the bank changes policy,” said Porter, who predicts no rate increase until July.

The U.S. Federal Reserve, Japanese and European central banks are still relying on asset purchases to revive demand and are keeping their interest rates close to record lows.

European Crisis

The Canadian dollar weakened 0.3 percent to C$1.0086 per U.S. dollar at 11:07 a.m. in Toronto, from C$1.0057 yesterday. One Canadian dollar buys 99.15 U.S. cents.

Investors have priced in a 20 percent chance of a rate increase in January, according to a calculation by Credit Suisse based on overnight index swap rates. The three-month swap rate, which measures what investors think the bank’s rate will average over that period, rose 0.03 percentage point to 1.04 percent.

“This statement is consistent with a very patient central bank that does not want to take the Canadian dollar to new heights by aggressively hiking before the Fed is prepared to move,” said Avery Shenfeld, chief economist at CIBC World Markets in Toronto.

European finance ministers have ruled out immediate aid for Portugal and Spain or an increase in the 750 billion-euro ($1 trillion) crisis fund, counting on European Central Bank bond purchases to calm markets a week after handing Ireland an 85 billion-euro lifeline.

‘Increased Risk’

“There is an increased risk that sovereign debt concerns in several countries could trigger renewed strains in global financial markets,” the Ottawa-based bank said in a statement today. “Any further reduction in monetary policy stimulus would need to be carefully considered,” the bank said, repeating a phrase it used at the last announcement.

Companies such as Montreal-based Bombardier Inc., the world’s third-biggest planemaker, are being hurt by weaker global orders. Canadian economic growth slowed to a 1 percent annualized third-quarter pace, less than the bank’s 1.6 percent October prediction, as exports fell and imports rose.

“A combination of disappointing productivity performance and persistent strength in the Canadian dollar could dampen the expected recovery of net exports,” the bank said.

Exports, which equaled 32 percent of Canada’s economy in 2009, declined by 1.3 percent between July and October, Statistics Canada said Nov. 30. About three-quarters of those shipments went to the U.S. last year. Imports of goods and services rose 1.6 percent.

Slowing Growth

Canada’s economy grew at a 5.6 percent pace in the first quarter of this year, boosted by government stimulus and housing. By the third quarter, the drag from trade slowed Canada’s expansion to less than half the 2.5 percent rate in the U.S.

Canada’s central bank led the Group of Seven earlier this year with three rate increases from June through September.

The Reserve Bank of Australia today also kept its benchmark interest rate unchanged at 4.75 percent, as the country’s growth slows and risks to the global economic recovery persist, saying inflation likely will be contained through mid-2011.

Canadian Prime Minister Stephen Harper last week extended a deadline for construction linked to government stimulus money by seven months to Oct. 31, and said that he was concerned about a “fragile” global recovery.

The European Central Bank increased its bond purchases last week after President Jean-Claude Trichet pledged to fight “acute” financial market tensions. U.S. Federal Reserve Chairman Ben S. Bernanke said Dec. 5 it’s possible the Fed may expand bond purchases beyond the $600 billion announced last month.

‘Ongoing Volatility’

“It’s the worries about ongoing volatility in the debt and foreign exchange markets that would support some caution in terms of communicating interest rate hikes,” said Derek Burleton, a senior economist at Toronto-Dominion Bank in Toronto, who predicts no rate increase until July.

There are signs domestic spending is still gaining, including a report last month showing inflation advanced at a 2.4 percent annual pace in October, the fastest in two years. Burleton said that gain, half of which came from gasoline costs, was probably a “blip.” The bank sets interest rates to keep inflation at 2 percent.

“Inflation dynamics in Canada have been broadly in line with the Bank’s expectations and the underlying pressures affecting prices remain largely unchanged,” the bank said today.

The Bank of Canada should extend its stimulus as the federal government has done, said Mike Pratt, president of the Canadian unit of Best Buy Co., the world’s largest consumer- electronics retailer.

“Anyone looking to fuel more demand and consumer confidence would hope that the Bank of Canada keeps interest rates low in sync with the stimulus extension timetables that were just announced” by Harper, Pratt said before the decision.

To contact the reporter on this story: Greg Quinn in Ottawa at gquinn1@bloomberg.net.

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net; David Scanlan at dscanlan@bloomberg.net.

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