Bank stands pat on rates

The Bank of Canada is taking a breather on interest rate hikes, announcing Tuesday morning that it would hold its trend-setting overnight rate steady at 4.25%.

“All factors considered, the Canadian economy is currently judged to be operating just above its production capacity,” the bank said. But it went on to say that 2007 and 2008 would likely see weaker economic growth, before returning to full capacity by the end of 2008.

“The additional strength that has developed in domestic demand is expected to persist into next year, but this should be more than offset by a weaker outlook for net exports, owing primarily to the recent strength of the Canadian dollar,” the bank added in a release accompanying the rate decision.

Canadian consumer inflation is expected to expected to average just 1.5% through the rest of this year and to the end of 2007, and the bank credits the 1% GST cut for lowering inflation by about 0.6% over this period. The target for core inflation remains 2%, which the bank expects in 2008.

“In line with the bank’s largely unchanged outlook, the current level of the target for the overnight rate is judged at this time to be consistent with achieving the inflation target over the medium term,” the central bank said.

BMO Nesbitt Burns deputy chief economist Douglas Porter points to the above as the key quote in the bank’s statement. “Effectively, they are suggesting that, as things stand, they are through tightening. It doesn’t get much clearer than that. The bank simply believes that its work is done, and needs a lot of convincing to get off the sidelines.”

The Bank also predicts “moderation” in the U.S. economy this year — central-banker-speak for slower growth. Today’s decision increases the spread between Canadian and U.S. interest rates to 1% — late last month, the U.S. Federal Reserve increase its overnight lending rate to 5.25%

“The bank will monitor global and domestic economic and financial developments, including adjustments in the Canadian economy, relative to its projection. Risks to the projection remain roughly balanced, with a small tilt to the downside later in the projection period related to global imbalances,” the report concludes.

There had been some debate among economists as to whether or not the bank would take such a pause. Higher than expected employment growth had led some bank watchers to predict the threat of higher inflation would force it to raise rates.

Last week, the C.D. Howe Institute’s Monetary Policy Council advised that the Bank raise rates by 25 basis points not only at today’s meeting, but also at the next meeting in September.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com