Canada Keeps 1% Lending Rate as Dollar Falls

The Bank of Canada kept its main interest rate unchanged and said the strength of the country’s dollar is hurting exporters, sending the currency to four-year lows.

Policy makers kept the benchmark rate on overnight loans between commercial banks at 1 percent, where it’s been since September 2010, as expected by all 21 economists in a Bloomberg News survey. Governor Stephen Poloz said his next interest rate move depends on how economic data change the balance of risks to the world’s 11th-largest economy.

Poloz’s language on the dollar “is a strong statement for the Bank, and as close as they will come to saying the currency is overvalued,” said Doug Porter, chief economist at BMO Capital Markets in Toronto. “The Bank is welcoming the weakening Canadian dollar with open arms, partly because it in turn reduces the pressure to consider trimming interest rates since the lower currency will begin to pump some life into inflation.”

Canada’s dollar weakened 1.1 percent to C$1.1087 at 5 p.m. today in Toronto. Government bond yields also declined, with the five-year security falling to 1.68 percent from 1.71 percent. Trading in overnight index swaps today shows investors adding to bets on an interest-rate cut by October.

“Despite depreciating in recent months, the Canadian dollar remains strong and will continue to pose competitiveness challenges for Canada’s non-commodity exports (CATBTOTB),” the bank said in its quarterly Monetary Policy Report.

Supporting Exports

The currency remains stronger than it was at any point from 1976 to 2006 -- as it averaged 1.2870 per U.S. dollar during that period.

“The strengthening of the global economy and recent depreciation of the Canadian dollar should foster a broadening of the composition of growth,” policy makers led by Poloz, 58, said in a statement from Ottawa today. “The timing and direction of the next change to the policy rate will depend on how new information influences this balance of risks.”

Speaking in an interview with BNN Television, Poloz said he wouldn’t “comment on whether the dollar should go up or down, that’s something the market does.” Asked whether today’s weakening showed that financial markets “got the message,” Poloz said “they seem to have understood what the issues are we’re working with.”

The bank’s updated forecast lifted the outlook for 2014 economic growth to 2.5 percent from 2.3 percent and said inflation will be further below target throughout 2014.

“There’s no change in the official bias but, as they did in October, they say the downside risks to inflation have grown,” said Mark Chandler, head of fixed-income research at RBC Capital Markets in Toronto. The currency’s decline “is less reflective of the statement itself and reflective of the spotlight that Canada is under.”

Cake Icing

Poloz told reporters at a press conference that the weaker currency will give an “extra kick” to the economy and likened it to icing on a cake, with support for exports coming mainly from accelerating U.S. growth. Canada sends three-quarters of exports to its southern neighbor.

Asked by BNN-TV if the statement is a sign that the bank has become more dovish, Poloz said: “In the way you define it, I suppose it is.”

“What we’re really saying is that given where we are, we’re prepared for another shock that could push inflation down,” Poloz told the Canadian television channel.

The bank reiterated the economy is around two years away from full output because company spending and shipments abroad have disappointed.

‘No Signs’

“As yet there are no signs of a rebalancing toward exports and business investment,” policy makers said. Exports will contribute 1.2 percentage points to Canada’s economic growth rate this year, up from the October forecast of 1 percentage point and four times the contribution made in 2012, the central bank said.

The Canadian dollar weakened past C$1.10 per U.S. dollar yesterday for the first time since 2009. The decline accelerated in October when the bank dropped language about the need to raise interest rates, and has come amid a slowing labor market and persistent trade deficits, leading investors to curb purchases of Canada’s top-rated government bonds.

The Bank of Canada’s shift away from talk of raising rates comes as the Federal Reserve begins to taper its asset-purchase program known as quantitative easing, while investors gain confidence in Europe’s economic improvement with Ireland and Portugal returning to the sovereign debt market. Poloz said he was “encouraged” by Europe’s progress in “healing” after its debt crisis.

Lower Assumption

The bank said its assumption for the currency, which it bases on the recent trading average, was lowered to around 91 U.S. cents from 97 U.S. cents.

Canada’s manufacturing base has shrunk, meaning a weaker currency will provide less of a spark than it would have in the past.

Bombardier Inc. (BBD/B) said yesterday it was cutting 1,700 jobs in its aerospace division, or about 6 percent of the work force. The Montreal-based company is working to produce its new CSeries regional jet, a plane whose debut has been pushed back four times.

Canada’s economy still has “significant” excess capacity and inflation is being held down by global weakness in food prices and a recent increase in retail competition, the bank said. Consumer prices will advance at an average year-over-year pace of 0.9 percent in the first quarter, below the bank’s 1 percent to 3 percent target band, before quickening to 1.5 percent in the fourth quarter.

The next inflation report, scheduled for Jan. 24, will show inflation accelerating to a 1.3 percent annual pace, according to a Bloomberg survey of economists.

‘Downside Risks’

“The downside risks to inflation have grown in importance,” the central bank said, echoing language from its last statement in December. The risks to the projection remain balanced, about the same as in October, the bank said.

While the threat to the economy posed by high consumer debt levels remain, “the evolution of the housing sector continues to support the bank’s soft-landing scenario,” policy makers said.

In the BNN TV interview, Poloz said Canadian housing gains have been in line with fundamentals, and that he’s not worried that recent moves to lower mortgage rates pose a threat.

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

To contact the editors responsible for this story: Paul Badertscher at pbadertscher@bloomberg.net; David Scanlan at dscanlan@bloomberg.net

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