Canada Keeps Key Rate at 1% in Flagging Inflation Risk

Bank of Canada Governor Stephen Poloz kept his main interest rate unchanged and said the risks of inflation staying below target “appear to be greater” in an economy that’s two years away from reaching full output.

Policy makers kept the benchmark rate on overnight loans between commercial banks at 1 percent, where it’s been for more than three years, as expected by all 22 economists in a Bloomberg News survey.

The decision was Poloz’s first since he surprised investors in October by dropping language about the need to raise interest rates in the future. The world’s 11th largest economy won’t reach full capacity until around the end of 2015, the central bank forecasts, with Poloz counting on gains in investment and exports to drive growth, instead of debt-laden consumers.

“The Bank judges that the substantial monetary policy stimulus currently in place remains appropriate,” the council led by Governor Poloz, 58, said in a statement from Ottawa today. “The risks associated with elevated household imbalances have not materially changed, while the downside risks to inflation appear to be greater.”

The statement didn’t mention the recent depreciation of Canada’s dollar, which dropped after the announcement past C$1.0700 versus its U.S. counterpart for the first time since May 2010, and traded at C$1.0699 at 12:22 p.m. in Toronto. Government bonds fell, with the yield on the 5-year benchmark rising three basis points to 1.77 percent.

“This is clearly a more dovish statement,” Avery Shenfeld, CIBC World Markets chief economist in Toronto, said in a telephone interview. “This may be part of a deliberate attempt to ease through the exchange rate.”

Risk Balance

“The balance of risks remains within the zone articulated in October,” policy makers said in their statement. “The Bank sees no reason to adjust its expectation of a gradual return to full production capacity around the end of 2015.”

Canada’s inflation rate slowed to 0.7 percent in October from a year earlier, outside the central bank’s target range of 1 percent to 3 percent. The 1.2 percent core inflation rate, which excludes eight volatile items, “is being held down by significant excess supply and by the effects of heightened competition in the retail sector, which look to be more persistent than anticipated,” the bank said.

“They are doing a very good job of turning the dial one notch at a time” toward easier monetary policy, said Doug Porter, chief economist at BMO Capital Markets in Toronto. “The bank has a really limited appetite for rate cuts,” he said, because policy makers “are still worried about household debt.”

‘Soft Landing’

Housing in Canada has been stronger than expected, policy makers said. The bank still expects a “soft landing,” according to their statement. The ratio of household debt to disposable income rose to a record 163.4 percent of disposable income in the second quarter on increased mortgage borrowing, according to Statistics Canada.

The nation’s economy grew at a 2.7 percent annualized rate in the third quarter, Statistics Canada reported Nov. 29. While the bank said the gain was faster than it expected, the growth doesn’t show “a rebalancing towards exports and investment.”

Potash Corp. of Saskatchewan Inc., the world’s largest fertilizer producer by market value, said yesterday it will pare its global workforce by 18 percent and reduce capacity amid weaker-than-expected demand in emerging markets.

Another Signal

Poloz’s decision to focus on inflation instead of growth was another signal he is concerned about the economy, Shenfeld at CIBC World Markets said. Third-quarter growth exceeded the bank’s October estimate of 1.8 percent.

“They could have taken the upside surprise in growth and used that to revise their projection and they didn’t,” Shenfeld said. “The bank is still convinced that we can’t keep milking the same cow forever, and that sources of growth we’ve been relying on including housing and consumer spending will eventually peter out.”

Poloz gives his next update in a Dec. 12 speech in Montreal and the next interest-rate announcement is Jan. 22, which will be accompanied by a new quarterly economic forecast.

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