Bank of Canada Drops Bias to Lift 1% Policy Rate

Bank of Canada Governor Stephen Poloz surprised investors by dropping language about the need for future interest rate increases, a move that’s leading to investor speculation about possible rate cuts.

Poloz removed the language, which had been in place for more than a year, citing greater slack in the economy, while keeping his benchmark rate on overnight loans between commercial banks at 1 percent for the 25th consecutive meeting today. The country’s currency and government bond yields fell after the announcement.

The central bank abandoned its tightening bias while maintaining warnings that Canadians are carrying too great a debt burden. Poloz told reporters that the current policy rate is still appropriate because it strikes an appropriate balance between the danger of excessive consumer spending and the risks of economic weakness.

“If you wished to take out some insurance against those risks, you would be exacting a price,” Poloz said. “The price would be in the form of increased risk on financial imbalances.”

Central banks from Santiago to Washington to Frankfurt are either sustaining or stepping up accommodation. Chile’s central bank on Oct. 17 unexpectedly cut its key interest rate by a quarter point for the first time in 21 months, citing slower economic growth and inflation and the weaker global outlook.

The Federal Reserve surprised markets last month by deciding not to taper $85 billion in monthly bond purchases. In July, European Central Bank President Mario Draghi said he would keep the ECB’s benchmark interest rate at its current level or lower for an “extended period.”

Dropped Language

Removing the bias in Canada “makes an already dovish central bank even more dovish,” said Derek Holt, vice-president of economics at Bank of Nova Scotia. The change represents “a fairly explicit nod by the Bank of Canada in the direction of wanting to tamp down some of the rate pressures that had swept through global fixed income markets,” he said by telephone from Toronto.

The Canadian dollar fell 1 percent to C$1.0385 per U.S. dollar at 4:16 p.m. in Toronto. One dollar buys 96.29 U.S. cents. Government bond yields fell, with the five-year security declining to 1.73 percent from 1.79 percent.

Investors have priced in about 6 basis points of interest rate increases by the end of 2014, based on trading in overnight index swaps. That compares with 8 basis points yesterday and 38 basis points at the end of July.

Delayed Improvement

The Bank of Canada said “uncertain global and domestic economic conditions are delaying the pick-up in exports and business investment,” leaving the economy weaker than had been expected, according to a statement from Ottawa today. The document dropped a phrase from the last decision about the expected “gradual normalization” of monetary policy.

“Markets will pay particular attention to the fact the forward language has been dropped,” said Toronto-Dominion Bank Chief Economist Craig Alexander.

Poloz said that if Canada received “more data flow which was negative for that inflation outlook” then the central bank “would need to re-think that balance of risks.”

“Those risks are balanced as we sit here,” Poloz said when asked if Canadian interest rate rises or cuts were equally likely. “Policy is dependent on the data flow and how it impacts our outlook for inflation.”

Alexander said the bank’s forecast “wouldn’t suggest the Bank is preparing the market for a cut in interest rates. What they are signaling is it’s going to take longer for the Canadian economy to absorb all the slack.”

Slow Inflation

Inflation will remain below the 2 percent target until the end of 2015, two quarters longer than forecast in July, with the risks of further weakness taking on “increasing importance,” policy makers led by Poloz, 58, said.

Royal Bank of Canada and National Bank Financial economists expected Poloz would keep the tightening bias he inherited from Mark Carney as a warning to consumers about the dangers of taking on too much debt. While policy makers said today they are taking into account the risk of making record household debt levels worse, the bank’s projections show growth will continue to be driven by consumers, with a lower contribution from exports and business spending.

The bank’s economic growth forecast for this year was cut to 1.6 percent from 1.8 percent. The outlook for 2014 was lowered to 2.3 percent from 2.7 percent, and the 2015 projection cut to 2.6 percent from 2.7 percent.

Excess Capacity

“Inflation in Canada has remained low in recent months, reflecting the significant slack in the economy,” the central bank said in its statement. The excess capacity in the economy is equal to about 1.5 percent of gross domestic product, which will help restrain inflation at an average of 1.2 percent in the first quarter of next year.

Business optimism over new investments fell to a four-year low in the central bank’s survey published earlier this month. Today’s forecast cut the contribution to 2014 growth from investment to 0.4 percentage point from 0.6 percentage point, and for net exports to 0.3 point from 0.6 point.

BlackBerry Ltd. of Waterloo, Ontario, the country’s biggest spender on research and development, has announced plans to fire 4,500 workers and is seeking a buyer for the company after sales of its signature smartphones fell short of forecasts.

The bank lowered its estimate for the growth rate of the economy’s potential output to 1.9 percent for this year and next, from 2.1 percent and 2.2 percent respectively. Slower growth in potential output reduces the amount that the economy can expand before it sparks inflation.

Policy makers also cut their forecast for growth next year in the U.S., which buys three-quarters of Canada’s exports, to 2.5 percent from 3.1 percent.

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