Bank of Canada Stays Neutral Calling CPI Rise Temporary

Bank of Canada Governor Stephen Poloz remained neutral on the direction of his next interest-rate move, saying broad economic weakness will curb a temporary quickening of inflation above his target.

Policy makers kept their benchmark rate on overnight loans between commercial banks at 1 percent, where it’s been for almost four years, and said faster inflation has been caused by one-time gains in energy and import prices, not changes in economic fundamentals.

Completing an economic recovery in two years “is reliant on continued stimulative monetary policy and hinges critically on stronger exports and business investment,” policy makers led by Poloz, 58, said in a statement from Ottawa today.

Poloz is seeking to nurse the world’s 11th largest economy back to full output with low interest rates while fulfilling a mandate to keep inflation at 2 percent, even with consumer-price gains exceeding his goal. The policy rate won’t rise until mid-2015 according to a Bloomberg economist survey, with recent data showing weakness such as rising unemployment and sluggish output growth.

“On both growth and inflation, they have become a touch more dovish,” said Randy LeClair, senior money manager at Manulife Asset Management in Toronto. “We’re probably into 2016 for seeing the Bank of Canada raising rates.”

Canada’s dollar strengthened 0.1 percent to C$1.0746 per U.S. dollar at 12:57 p.m. Toronto time. Two-year government bond yields fell one basis point to 1.09 percent.

Weaker Dollar

Canada’s inflation rate has risen because of temporary forces such as gains in energy costs and tighter meat supplies, the central bank said today. Some of those pressures are being balanced by increased retail competition and slack in the economy, policy makers said.

“The Bank is neutral with respect to the timing and direction of the next change to the policy rate, which will depend on how new information influences the outlook and assessment of risks,” the bank said in the one-page interest rate decision. All 21 economists surveyed by Bloomberg News anticipated the unchanged policy rate.

Inflation will peak at a quarterly average of 2.2 percent between October and December, the central bank forecast today, up from its April estimate of 1.9 percent. Consumer price gains will slow to 1.7 percent in the second quarter of next year before stabilizing at 2 percent in 2016, it said.

The revisions are “quite dovish,” Robin Brooks and Michael Cahill strategists at Goldman Sachs Group Inc. wrote in a report. “The Bank is still distrustful that it has put the recent low inflation episode behind it.”

Core Inflation

The core inflation rate, which excludes eight volatile items, will reach 1.8 percent in the fourth quarter and slow to 1.6 percent in the first half of next year before returning to 2 percent in 2016, according to the bank’s forecast.

“Underlying inflationary pressures remain muted,” the central bank said in its quarterly economic forecast paper, the Monetary Policy Report. “Beyond the near term, the inflation projection is little changed,” from three months ago.

May’s 2.3 percent inflation rate marked the first time consumer price gains exceeded the central bank’s 2 percent target in more than two years. Inflation has averaged 1.3 percent since Poloz took the job in June 2013.

‘Serial Disappointment’

The economy won’t reach its full potential until mid-2016, the bank said, about three months later than in its April projection. The bank also cut its forecasts for Canada’s growth, to 2.2 percent from 2.3 percent for this year and to 2.4 percent from 2.5 percent next year.

The global recovery has offered “serial disappointment,” the bank said, cutting its 2014 world growth projection to 2.9 percent from 3.3 percent, led by weakness in the U.S., Europe and China.

“Right now we don’t have a sustainable growth picture in Canada,” Poloz said at a press conference. Business investment is hesitant globally and Canada’s non-energy exports are lagging behind gains in U.S. demand, he said.

Canada’s weak job market also suggests “material excess capacity in the economy,” the bank said in its report. The ‘elevated’’ unemployment rate of about 7 percent would have been higher if people hadn’t left the labor force in the past six months, the bank said.

Loose Policies

Other central banks are maintaining loose policies. U.S. Federal Reserve Chair Janet Yellen told lawmakers yesterday the central bank must press on with monetary stimulus as “significant slack” remains in labor markets and inflation is still below the Fed’s goal. The Reserve Bank of Australia kept the cash rate unchanged at a record-low 2.5 percent this month and reiterated it expects a period of stable interest rates.

The global weakness has put pressure on Canada’s exporters, and the central bank said today the recovery of shipments abroad “will continue to be drawn out.”

Velan Inc., a Montreal-based maker of industrial valves, said July 10 that net income in the three months ending May 31 fell to 18 Canadian cents a share from 26 cents a year earlier, in part because of a decline in “large export project” orders.

The central bank also reiterated today there will be a “soft landing” in the housing market after rising sales boosted the ratio of household debt to disposable income to a record last year.

“I believe they remain neutral and leaning dovish,” said Jimmy Jean, a Montreal-based strategist with Desjardins Securities, in an e-mail. “Eventually, from the forecast, the next move will be a hike, but a clearly distant one.”

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