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Canada Keeps Key Rate at 1%; Stimulus ‘Will Be Withdrawn’

Bank of Canada Keeps Key Rate at 1%
The Bank of Canada building stands in Ottawa, Ontario, Canada. Photographer: Patrick Doyle/Bloomberg

The Bank of Canada kept its main interest rate unchanged and said borrowing costs will increase as the economy recovers, with policy makers dropping the word “eventually” to describe the timing of their next move.

The target for overnight loans between commercial banks remained 1 percent, where it’s been since September, as forecast by all 26 economists surveyed by Bloomberg News. The Ottawa-based bank also raised its outlook for so-called core inflation and affirmed the economy will reach full output by the middle of 2012 while trimming this year’s growth forecast.

“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in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn,” the central bank said in a statement. “Such reduction would need to be carefully considered.”

The Canadian dollar and bond yields rose as investors bet today’s statement could mean rate increases come sooner than previously forecast. Policy makers led by Governor Mark Carney, 46, focused on faster inflation at home as well as Europe’s debt crisis and a weak U.S. economy. The annual inflation rate was 3.7 percent in May, the fastest since 2003 and above the bank’s 2 percent target.

“By taking out the word eventually, it’s signaling the wait for interest rate hikes isn’t going to be as long as the markets were assuming,” said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce in Toronto.

Dollar Strengthens

The Canadian dollar appreciated 0.9 percent to 95.15 cents per U.S. dollar at 11:11 a.m. in Toronto, from 95.97 cents yesterday. It earlier reached 94.82, the strongest level since May 3. One Canadian dollar buys $1.0510.

The yield on the two-year Canadian government bond rose 7 basis points to 1.46 percent, and the yield on the December bankers acceptance contract rose to 1.47 percent from 1.38 percent.

The bank today reiterated that inflation will exceed 3 percent “in the near term” because of temporary increases in food and energy costs, with the rate expected to slow to 2 percent by mid-2012.

Policy makers also said that core inflation, which excludes eight volatile items, “is slightly firmer than anticipated” because of “temporary factors” and the cost of some services. Core inflation will “remain around 2 percent” through 2013, they said, faster than their April prediction that it would be remain below 2 percent until the second quarter of next year.

Slower 2011 Growth

Economic growth this year will be 2.8 percent, the bank said, less than its April forecast of 2.9 percent. While household spending will be stronger than previously forecast, exports will be weaker, the bank said. The forecasts for 2.6 percent growth in 2012 and 2.1 percent in 2013 were unchanged.

The bank also said that its outlook “assumes that authorities are able to contain the ongoing European sovereign debt crisis, although there are clear risks around this outcome.”

“The bank has been very straightforward, they are going to raise rates,” said Andrew Gretzinger, part of a team that manages C$17 billion in assets for Manulife Asset Management in Toronto. “With all the concerns out there with Greece, the European Union and the U.S. debt ceiling issue, that’s creating a drag.”

Gretzinger, the most accurate forecaster of Canadian data for Bloomberg News surveys in 2009 and 2010, said the rate increase will come late this year or next year if the global risks worsen.

Persistent Dollar Strength

Policy makers also said that growth in the U.S., which buys three-quarters of Canada’s exports, has been weaker than expected and the “persistent” strength in the Canadian dollar is a drag on exports.

“We expect to see continued gradual economic recovery as we’ve seen for much of the past year,” restaurant chain Tim Hortons Inc. Chief Financial Officer Cynthia Devine said on a June 7 conference call. She also said that high gasoline prices and commodity costs represent a “wild card” for the company.

Carney will hold a press conference at 11:15 a.m. New York time tomorrow after the bank publishes its Monetary Policy Report, a quarterly economic forecast paper.

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