Bank of Canada Keeps 1% Policy Rate Saying Increases to Come ‘Eventually’

Bank of Canada policy makers kept their key interest rate unchanged today and added language about a potential increase for the first time since September, saying they will raise rates “eventually” as the economy recovers.

The target for overnight loans between commercial banks remained 1 percent, where it has been since September, as projected by all 24 economists surveyed by Bloomberg News. The Canadian dollar rose the most since December on the language about a future increase.

“To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be eventually withdrawn,” Governor Mark Carney, 46, and his five deputies said in a statement from Ottawa today. “Such reduction would need to be carefully considered,” the statement said, echoing words used in every interest rate announcement since September.

The bank said today Canada’s recovery is “proceeding largely as expected,” adding that any interest rate increase would be “consistent with achieving the 2 percent inflation target.” It said last month that growth may slow in the April- June period to about half the pace seen in the first quarter as indebted consumers and governments pull back and auto production slows after disruptions linked to natural disasters in Japan.

‘Rough Spot’

“It does point to getting through a rough spot and then raising rates,” said Dawn Desjardins, assistant chief economist at Royal Bank of Canada in Toronto. She expects a September increase.

The Canadian currency rose as much as 1.2 percent to 96.55 cents per U.S. dollar, and traded for 96.86 at 10:42 a.m. in Toronto, compared with 97.71 cents yesterday. One Canadian dollar buys $1.0324. Bond yields jumped, with the 2-year benchmark rising as much as 6 basis points to 1.58 percent after the announcement.

The yield on the December 2011 bankers acceptance contract, a barometer for short-term rate expectations, jumped 3 basis points to 1.38 percent, indicating traders are increasing bets on a rate increase this year. The yield had declined to 1.35 percent yesterday, the lowest since August.

Japan’s output interruptions will “restrain growth sharply” in Canada this quarter while Europe’s expansion is “maintaining momentum” even as risks in some peripheral economies have “increased,” the Bank of Canada said today.

Growth to Slow

Canada’s economy, the world’s 11th-largest, expanded at a 3.9 percent annualized pace between January and March, Statistics Canada said yesterday. The Bank of Canada said last month growth is likely to slow to a 2 percent annual pace in the April-June period, and that the rise in inflation to 3.3 percent in March and April was driven by temporary factors such as higher taxes and food and energy costs.

Trading in swaps contracts showed investors began betting on balance that a rate increase wouldn’t happen until October following a May 20 report that showed inflation was less than economists forecast.

“The expectations got way off I think and now things are more aligned to reality” said Jimmy Jean, a strategist in the fixed-income group at Desjardins Capital Markets in Montreal. “It’s the kind of report I would have liked to have seen in April,” he said, referring to the last rate decision.

Difficult to Control

Jean pointed to the bank’s view that the economy will reach full capacity by the middle of next year as a sign that it would be difficult to control inflation if policy makers kept rates unchanged until late this year.

Inflation will move toward the bank’s 2 percent target by the middle of next year, policy makers reiterated today, adding that growth of the consumer price index will exceed 3 percent “in the short term.”

U.S. Federal Reserve Chairman Ben S. Bernanke has also said in recent speeches that the threat from accelerating prices will be “transitory.” Central bankers there are discussing how quickly to begin tightening policy after completing the purchase of $600 billion in U.S. Treasuries by the end of June.

Canada’s announcement today will be followed in June by policy makers from the other Group of Seven nations, starting with the European Central Bank and Bank of England June 9. Carney led the group with three increases last year before pausing to judge the strength of the world economy.

Economists surveyed by Bloomberg predict no move by the Fed until the first quarter of next year, and that the Bank of Canada will raise its rate at its Sept. 7 meeting. The European Central Bank raised rates in April for the first time in almost three years to 1.25 percent.

U.S. Shipments

Canada sends about 75 percent of its exports to the U.S., and those shipments are at risk as the Canadian dollar rallied to 94.46 cents on April 29, the strongest since November 2007, Carney has said.

“The persistent strength of the Canadian dollar could create even greater headwinds for the Canadian economy, putting additional downward pressure on inflation through weaker-than- expected net exports and larger declines in import prices,” the bank said today, echoing its last statement.

Trade was a drag in the first quarter as imports rose faster than imports, even as shipments abroad of energy rose 8.9 percent, Statistics Canada said yesterday. Consumer and government spending were both flat after previous gains, which economists said suggests weaker future growth momentum.

Margins Squeezed

“Our margins were squeezed by a combination of lower volume, higher input cost and a significant strengthening of the Canadian dollar compared to the U.S. dollar and euro,” Tom Velan, chief executive officer of industrial valve maker Velan Inc., said on a May 17 earnings call.

Prime Minister Stephen Harper won the May 2 election, and Finance Minister Jim Flaherty said he will present a June 6 budget that will show Canada set to eliminate its budget deficit by 2014. During the election campaign, Harper said the government could find C$4 billion a year in program spending reductions.

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

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

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