Bloomberg News

Bank of Canada Keeps 1% Policy Rate, Cuts Growth Outlook

October 25, 2011

(Updates with analyst comment in seventh and 14th paragraphs.)

Oct. 25 (Bloomberg) -- The Bank of Canada cut its growth outlook for the Canadian economy and removed a reference to withdrawing stimulus in a statement today that may signal Governor Mark Carney will extend his pause on borrowing costs to as late as 2013.

The economy will grow less than projected and take longer to return to its capacity level as weak U.S. growth and a “brief” European recession hurt confidence and reduce export demand, the central bank said after keeping its policy rate at 1 percent. Inflation will also be slower than earlier forecast, falling to as low as 1 percent next year, the Ottawa-based bank said in a statement.

“The outlook for the Canadian economy has weakened since July, with the significantly less favorable external environment affecting Canada through financial, confidence and trade channels,” the bank’s governing council, led by Carney, 46, said today. While the economy rebounded from a contraction in the second quarter, “economic momentum has slowed and is expected to remain modest through the middle of next year.”

Canada’s currency and bond yields fell following the report, as investors raised bets Carney would wait longer to raise borrowing costs from levels the Bank of Canada calls “historic lows”, or even cut interest rates if the global economy deteriorates further.

Dollar Declines

The dollar fell 1.3 percent to C$1.0171 per U.S. dollar at 11:12 a.m. in Toronto. It had traded as high as 99.91 Canadian cents per U.S. dollar before the release. The yield on the Government of Canada two-year bond plunged 9 basis points to 1.01 percent.

Carney’s decision to keep the bank’s target for overnight loans between commercial banks at 1 percent was forecast by all 27 economists surveyed by Bloomberg.

“It was understood that they would be dovish, but they went the extra mile,” said Derek Holt, Scotia Capital’s vice president of economics in Toronto. “It’s a much more aggressive signal that policy’s on hold throughout the rest of this year, next year and well into 2013.”

Keeping the policy rate at 1 percent until 2013 would match the expected path of U.S. policy makers, Holt said, with the Federal Reserve led by Ben S. Bernanke saying it will keep rates at a record low through at least mid-2013.

Crisis Seen Contained

The Bank of Canada said today the global economy has “slowed markedly” amid rising financial market volatility and reduced “risk-taking” by investors. While the central bank predicted a recession for Europe, it said it expects the euro- area crisis to be “contained.”

The U.S. economy will generate “weak” growth through the first half of 2012, while expansions in emerging-market economies such as China should also moderate, it said.

“These developments, combined with recent declines in commodity prices, are expected to dampen global inflationary pressures,” the Bank of Canada said.

The bank reduced its forecast for inflation, projecting a decline in the core rate, which removes volatile items such as gasoline, through 2012. Total inflation will slow to as low as 1 percent by the middle of next year before rising with so-called core inflation to the bank’s 2 percent target by the end of 2013, the central bank projected.

In July, the bank had projected the core inflation measure -- which strips out eight volatile prices and is used by the bank to gauge future inflation pressure -- to remain near 2 percent through the end of 2013.

‘So Bearish’

“They’re so bearish on growth prospects that they don’t expect any real pricing power to evolve over the course of the next year in a manner that would challenge their inflation target,” Holt said.

The Canadian central bank reduced its forecast for Canadian growth this year to 2.1 percent from a 2.8 percent estimate in July. Growth next year will be 1.9 percent, down from a 2.6 percent estimate, the bank forecast. It raised its growth projection for 2013 to 2.9 percent from 2.1 percent.

The economy won’t return to full capacity until the end of 2013, the central bank said, 18 months longer than it had forecast in July.

There was no reference to withdrawal of stimulus in today’s statement. In July, the central bank said “some of the considerable monetary policy stimulus currently in place will be withdrawn,” while at its Sept. 7 announcement, the bank said “the need to withdraw monetary policy stimulus has diminished.”

Swap Rates

Swap rates suggest investors are betting the central bank may even lower borrowing costs in coming months. The six-month overnight index swap rate, which is based on what investors expect the central bank’s rate will average during that period, fell 4 basis points to 0.918 percent, while the one-year rate dropped 7 basis points to 0.850 percent.

A reduction in interest rates is unlikely, though, when household debt is at record levels and unemployment has been falling, said Mark Chandler, head of Canada fixed-income strategy at RBC Capital Markets in Toronto.

“We’re in a period of challenged growth, and it gets really hard to move in one direction or another,” Chandler said.

In its statement today, the bank said “with the target interest rate near historic lows and the financial system functioning well, there is considerable monetary policy stimulus in Canada.”

--With assistance from Ilan Kolet in Ottawa. Editors: Paul Badertscher, Vince Golle

To contact the reporter on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net;

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net; David Scanlan at dscanlan@bloomberg.net.


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