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Bank of Canada Says Consumers for Growth as Exports Lag

The Bank of Canada said consumers and business investment will lead modest economic growth through 2014 while weaker global demand curbs exports that are having the weakest recovery since World War II.

Consumption will provide 1.1 percentage points of growth this year and spending on housing 0.4 points, accounting for almost three-quarters of a 2.1 percent expansion, the Ottawa-based central bank said today in its monetary policy report.

Governor Mark Carney kept his key interest rate at 1 percent yesterday and reiterated his next move may be an increase, even while trimming his economic forecast and as central banks in the U.S., Europe and Asia add stimulus. Some investors are betting Carney will cut rates as the world’s 10th largest economy is dragged down by Europe’s fiscal crisis and a prolonged U.S. recovery.

Asked about Canada running counter to other countries, Carney said “global monetary policy isn’t a cut-and-paste,” adding “there is a very small amount of excess capacity in the economy, rates are at 1 percent, they are very low.”

The bank’s outlook “includes a gradual reduction in monetary stimulus over the projection horizon, consistent with achieving the inflation target,” policy makers said in the report, repeating language from its last report in April.

Housing Market

Canada’s housing market is showing “signs of overbuilding” and Finance Minister Jim Flaherty’s moves last month to tighten mortgage rules should make the market “more sustainable,” today’s report said. Housing investment will not add to growth in 2013 and 2014, the central bank forecast.

Business investment will add 0.8 percentage points to the economic growth rate in 2013 and 2014, the bank said.

The central bank cut its growth outlook for this year to 2.1 percent from April’s 2.4 percent projection, and for 2013 to 2.3 percent from 2.4 percent. Part of that stems from a drop in the price of crude oil, one of Canada’s biggest exports, Carney said today. Crude oil has declined 9.4 percent this year based on New York Mercantile Exchange prices.

“This is the story of the Bank of Canada over the last few years,” said Thanos Bardas, a managing director in Chicago at Neuberger Berman LLC, which oversees about $89 billion in fixed-income assets. “Every time they would like to raise rates because they think the economy is nearing full potential there are external events that get in the way.”

Inflation Target

On a quarterly basis, the bank said Canada’s economy expanded at a 1.8 percent annual pace in the April-June period, and forecast 2 percent growth in the current quarter. The expansion will accelerate to a peak of 2.7 percent in the fourth quarter of next year, it projected.

“The Canadian growth profile is now arguably worse than it was even in last January’s MPR when there was no tightening bias,” said Krishen Rangasamy, senior economist with National Bank in Montreal, in a note to clients. The central bank “may have decided to keep the tightening bias in July to counter expectations of rate cuts by markets.”

The Bank of Canada sets interest rates to meet a 2 percent inflation target. It said today inflation will slow to an average of 1.2 percent in the third quarter because of lower oil prices before returning to 2 percent one year later.

The economy was operating about half a percentage point below full capacity in the second quarter, the bank said, unchanged from its first quarter estimate.

‘Modest Withdrawal’

“To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate,” the central bank said.

Net exports will contribute 0.1 percentage point to growth next year and 0.2 point in 2014, the report said. Shipments abroad are being held back by the Canadian dollar’s persistent strength, a loss of competitiveness and weaker growth in the U.S., Europe and emerging markets, the bank said. Exports are in the slowest recovery since after World War II and won’t return to levels seen before the last recession until the start of 2014, the bank said.

Europe’s economy will probably contract in the last three quarters of this year with weakness seen in countries such as Greece spreading to so-called core countries, the Bank of Canada said. The bank reduced its growth profile for the U.S. economy, saying the recovery will be limited by a weak labor market and the need for governments to curb deficits.

Bond Yields

Canada’s benchmark 10-year bond yield dropped to a record low this week on demand for the safest assets amid speculation the U.S. economy is slowing. The Canadian dollar gained 0.1 percent to 1.0109 per U.S. dollar at 1:47 p.m. in Toronto, while Canadian stocks gained for a fourth day.

The bank’s forecast assumes the Canadian dollar will trade at about 98 U.S. cents through 2014, compared with an April assumption of 101 U.S. cents. The central bank also said it’s assuming U.S. politicians will avoid a sudden mix of tax increases and spending cuts -- dubbed a “fiscal cliff” --after elections later this year, while Europe’s debt crisis will be contained.

Carney also spoke today about reports of possible manipulation of the London interbank offered rate, or Libor, calling them “deeply troubling.”

There is “a possibility” Libor can’t be “fixed” and any solution may be on a currency-by-currency basis, he said. In Canada, Carney said he hasn’t seen any evidence of manipulation, adding that the central bank’s role has been limited to providing “technical assistance” to the Commissioner of Competition’s investigation.

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