Canada Stays Neutral on 1% Policy Rate on Economic Slack

Bank of Canada Governor Stephen Poloz extended the country’s interest-rate pause to four years today and remained neutral on his next move, citing slack in the economy that will keep inflation in check.

Policy makers held the benchmark rate on overnight loans between commercial banks at 1 percent and said the recent jump in exports must be sustained before it triggers the business investment needed to bring the economy to full capacity over the next two years. The decision from Ottawa was expected by all 18 economists in a Bloomberg News survey.

The bank “made it abundantly clear that it saw no prospect for a change any time soon,” Avery Shenfeld, chief economist at CIBC World Markets in Toronto, wrote in a research note. “The key message is that the next move in rates could still be up or down, largely because it is seen as distant enough to be uncertain in either timing or direction.”

The decision extends Canada’s longest rate pause since the 1950s and economists predict Poloz won’t tighten policy before next year as the recovery builds. The bank’s one-page statement contained multiple references to the economy advancing as anticipated, and said the recent quickening of inflation past the 2 percent target was due to temporary factors.

“The Bank remains neutral with respect to the next change to the policy rate: its timing and direction will depend on how new information influences the outlook and assessment of risks,” policy makers led by Governor Poloz, 58, said from Ottawa today.

Stronger Dollar

Canada’s dollar strengthened further after the decision, appreciating 0.5 percent to C$1.0877 per U.S. dollar at 11:42 a.m. in Toronto. Two year-government bond yields were little changed at 1.13 percent.

The nation’s main equities gauge, the Standard & Poor’s/TSX Composite Index, rose 15.82 points, or 0.1 percent, to 15,634.90 in Toronto after climbing to a record 15,685.13.

Canada’s inflation rate slowed to 2.1 percent in July from 2.4 percent in June, after accelerating from 0.7 percent in October. The rise in the inflation rate was caused by a temporary increase in energy prices and the effect of a weaker currency, and not “any change in domestic economic fundamentals,” the bank said today.

Exports in the second quarter were supported by stronger U.S. demand and the past depreciation of the Canadian dollar, the Bank of Canada said today. Shipments abroad jumped at an annualized 17.8 percent pace between April and June, leading the 3.1 percent gain in gross domestic product.

“While an increasing number of export sectors appear to be turning the corner toward recovery, this pickup will need to be sustained before it will translate into higher business investment and hiring,” the central bank said today.

Subdued Investment

Canada’s dollar has weakened about 6 percent against the U.S. dollar since Poloz replaced Mark Carney in June of last year. Business investment has remained subdued even amid signs of stronger growth in the U.S. economy, where the expansion reached a 4.2 percent rate in the second quarter.

Poloz has repeatedly said that the economy needs a rotation toward exports and investment, and away from debt-fueled household consumption, to reach a full and sustainable recovery.

“The Bank of Canada is more than happy to wait a little bit longer for that rotation in demand,” Michael Gregory, deputy chief economist at BMO Capital Markets, said by telephone from Toronto. “I think it’s going to take a year for it to really materialize.”

The housing market has advanced faster than policy makers anticipated, the central bank said today, adding that risks remain from the associated buildup of consumer debt. It dropped a reference from its last statement that household debts were evolving constructively.

Policy Zone

The risks to the bank’s inflation projection remain “within the zone for which the current stance of monetary policy is appropriate,” the Bank of Canada said today.

On the global economy, the central bank also dropped language about “serial disappointment” with growth, saying that “a solid recovery seems to be back on track” in the U.S. while “the recovery in Europe appears to be faltering as the situation in Ukraine weighs on confidence.”

Canada’s policy rate remains the highest in Group of Seven nations even after the four-year pause, with former Governor Carney raising it three times to 1 percent from the record low 0.25 percent set during the global financial crisis. Poloz dropped a bias to raise rates that existed as Carney left.

“It’s not so much that it’s been a Poloz stamp on the bank,” Leslie Preston, an economist at Toronto-Dominion Bank in Toronto, said in a telephone interview. The world economy “shifted in a dovish direction,” she said.

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