Carney Poised to Leave Rates Unchanged Amid Global Weakness

Bank of Canada Governor Mark Carney will probably leave his main interest rate unchanged today and signal he is prepared to extend a yearlong freeze amid signs of global weakness and financial-market volatility.

Carney will keep the Ottawa-based central bank’s target for overnight loans between commercial banks at 1 percent, according to all 27 economists surveyed by Bloomberg News. The bank likely will also reduce its outlook for growth in the release today.

Policy makers, faced with a European debt crisis and a slow U.S. rebound that could hamper Canada’s recovery, have sought to pare back forecasts of interest rate increases over the past month. A reduction in interest rates, meanwhile, is unlikely at a time when household debt is at record levels and unemployment has been falling, said Mark Chandler, head of Canada fixed-income strategy at RBC Capital Markets in Toronto.

“We’re in a period of challenged growth, and it gets really hard to move in one direction or another,” Chandler said. “The risks are essentially balanced.”

The central bank, in a quarterly forecast tomorrow, will also reduce its growth projections over the next three quarters by an average of about 0.75 percentage points and extend the time when Canada’s economy is forecast to return to its full capacity to the start of 2013, Chandler said in a report.

The Bank of Canada predicted in July the economy would operate at full capacity in the middle of next year. While the central bank forecast 1.5 percent annualized growth in the second quarter, Canada’s economy shrank at a 0.4 percent pace.

Growth Misses Forecasts

The central bank also forecast 2.8 percent annualized growth in the third quarter, and 2.9 percent in the final three months of this year. Economists surveyed by Bloomberg this month estimate growth of 2 percent in the third quarter, and 2.1 percent in the fourth quarter.

Other indicators suggest Carney may be reluctant to raise interest rates. A Bank of Canada survey of executives released last week found the least optimism about future sales growth since the beginning of 2009, with signs of weak global demand leading companies to curb hiring and investment plans. The bank’s financial conditions index, which gauges the impact on the economy of bond yields, stock prices and other measures, fell to the lowest since 2009 this month, as spreads on corporate bonds widened amid the global financial turmoil.

The extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government rose to a 27-month high of 195 on Oct. 6, before narrowing to 189 at the end of last week, Bank of America Merrill Lynch index data show.

‘Heightened Financial Uncertainty’

At its last interest rate announcement, the Bank of Canada said there was a “diminished” need for higher borrowing costs “in light of slowing global economic momentum and heightened financial uncertainty.”

Carney followed up that statement with a Sept. 20 speech where he said the domestic economic recovery will be hobbled by a weak U.S. recovery that could tip into another recession, and that he may extend a period of low interest rates beyond when full output is restored.

Carney also said the bank has “considerable flexibility” in how fast it returns inflation to its target. “The Bank always takes a flexible approach,” Carney said. “Our decisions are guided by considered analysis and informed judgment rather than mechanical rules.”

Investors have bet that accelerating inflation and a return to growth may not trigger higher borrowing costs, or deter lower rates if the global environment deteriorates.

Swap Rates

The three-month overnight index swap rate, which is based on what investors expect the central bank’s rate will average during that period, was trading at 0.9675 percent late yesterday, while the one-year rate at 0.9100 percent.

In a Bloomberg survey of 21 economists earlier this month, 19 predicted Carney will keep interest rates unchanged at 1 percent through the year, with two predicting a cut. Interest rates will likely remain unchanged until the third quarter of next year, when Carney will begin raising borrowing costs again, according to the survey’s median estimate.

Louis Gagnon of Kingston, Ontario-based Queen’s University said inflation makes a rate cut is unlikely. “I don’t expect a rate cut, with all due respect to the market,” Gagnon, a professor of finance at Queen’s said in a telephone interview, “simply because inflation has gone up above target.”

Statistics Canada reported Oct. 21 that Canada’s annual inflation accelerated in September, and a measure of price increases that factors out volatile items reached the highest in almost three years. Inflation has been above the Bank of Canada’s 2 percent target for 10 straight months.

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