Bank of Canada Keeps Higher Rate Bias in Slower Rebound

The Bank of Canada kept its main interest rate at 1 percent and said an increase remains possible, while adding the domestic recovery will be slowed by weaker global demand for exports.

The world’s 10th largest economy won’t reach full output until the second half of next year, compared with an April prediction for the first half of 2013, the Ottawa-based central bank said. The decision was forecast by all 24 economists surveyed by Bloomberg News.

“While global headwinds are restraining Canadian economic activity, domestic factors are expected to support moderate growth,” policy makers led by Governor Mark Carney, 47, said in a statement. “Some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.”

The statement comes as central banks around the world are easing policy. The U.S. Federal Reserve and the Bank of England expanded programs to buy assets in the last month, while the People’s Bank of China and the European Central Bank cut their main interest rates.

Canadian policy makers are “quite worried about the situation in Europe and the possible collateral damage,” said Sal Guatieri, senior economist at BMO Capital Markets in Toronto, who predicts no increase for a year. “There is very little urgency to raise interest rates.”

Forecasts Trimmed

Housing and employment gains are being offset by the drag from a merchandise-trade deficit and reduced confidence stemming from Europe’s debt crisis. The central bank’s economic growth forecasts were trimmed to 2.1 percent this year from 2.4 percent, and to 2.3 percent in 2013 from 2.4 percent. The 2014 projection was raised to 2.5 percent from 2.2 percent.

Canada’s dollar weakened 0.1 percent to C$1.0163 per U.S. dollar at 11:04 a.m. in Toronto. One Canadian dollar buys 98.40 cents. The Standard & Poor’s/TSX Composite Index of stocks fell 0.2 percent to 11,495.87.

While inflation will “remain noticeably below the 2 percent target over the coming year” because of lower oil costs, the Bank of Canada said that core inflation, which is used as a guide to future price pressures, will stay near 2 percent through 2014.

“Our view is 2013 won’t be any better than 2012 and rate hikes could be put off until early 2014,” said Avery Shenfeld, chief economist at CIBC World Markets in Toronto. “If you knock a couple ticks off 2013, you don’t get to full output on time.”

Global Slowdown

About three-quarters of Canada’s exports are sent to the U.S. where the expansion has slowed, while “developments in Europe point to a renewed contraction,” the central bank said. Emerging-market growth has also decelerated and there has been “a sizable reduction” in prices for Canada’s exported commodities, according to the report.

Companies such as Tembec Inc. are feeling the global slowdown. Tembec said July 10 it would idle a pulp mill in Chetwynd, British Columbia, because the market “has continued to soften over the past year.”

Trading in overnight swaps showed about a 78 percent chance the key rate will still be 1 percent after the bank’s Dec. 4 decision, compared with a 70 percent chance yesterday.

Canada’s benchmark 10-year bond yield dropped to a record low yesterday on demand for the safest assets amid speculation the U.S. economy is slowing. Today the 2.75 percent security maturing in June 2022 fell 10 cents to C$110.20. The yield rose 1 basis point to 1.63 percent.

May Weakness

Canada factory shipments fell unexpectedly and the merchandise trade deficit widened to the most in almost a year in May as energy exports fell. While the housing market has helped drive Canada’s recovery, Finance Minister Jim Flaherty’s Conservative government tightened mortgage rules last month, citing concern that some people were taking on debts that would become unaffordable when interest rates rise.

“We remain concerned that the economy, both internationally and domestically, is fragile,” said Sean Jackson, chief executive officer of Toronto-based Meridian Credit Union, Ontario’s largest with C$8 billion ($7.9 billion) in assets.

Exports will remain below their pre-recession peak until the start of 2014 as companies struggle with the Canadian dollar’s “persistent strength” and to regain competitiveness, the bank said.

Canada’s recovery will be led by consumption and business investment, according to the bank, with the pace held back by the drag of global weakness on domestic incomes and record high consumer debt levels.

Federal Reserve Chairman Ben S. Bernanke said today that progress in reducing U.S. unemployment is likely to be “frustratingly slow” and repeated the Fed is ready to take further action to boost the recovery, while refraining from discussing specific steps.

The Bank of Canada will give details of its updated forecast in a monetary policy report scheduled to be published tomorrow.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE