Bank of Canada holds rate at 1%

Posted on October 19, 2010

JEREMY TOROBIN

OTTAWA— Globe and Mail Update

Bank of Canada Governor Mark Carney kept his benchmark interest rate at 1 per cent Tuesday after three consecutive increases, saying the domestic recovery will be more gradual than expected, the U.S. rebound will be weaker than projected, and the global turnaround is ``entering a new phase.’’

In explaining his decision, Mr. Carney said while private demand in advanced economies will become ``sufficiently entrenched’’ to sustain the recovery, a combination of high unemployment and efforts by governments and households to trim the debt they piled up during the recession will slow the pace of growth. Also, expansion in the emerging markets that have powered the global recovery will slow to a ``more sustainable pace,’’ Mr. Carney said, as they take steps to keep their economies from overheating. And spending by Canadian households will moderate as they try to live within their means after a long stretch of record-low borrowing costs.

``At this time of transition in the global recovery, with a weaker U.S. outlook, constraints beginning to moderate growth in emerging-market economies, and domestic considerations that are expected to slow consumption and housing activity in Canada,’’ the central banker said in the statement accompanying his decision, ``any further reduction in monetary policy stimulus would need to be carefully considered.’’

The Canadian economy will grow at a 3-per-cent pace this year, 2.3 per cent in 2011 and 2.6 per cent in 2012, the central bank said. That compares with Mr. Carney’s July forecast of 3.5 per cent growth for this year, 2.9 per cent in 2011 and 2.2 per cent in 2012.

``The economic outlook for Canada has changed,’’ Mr. Carney said. ``This more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending.’’

Mr. Carney’s decision comes days before he meets with Group of 20 central bankers and finance ministers in South Korea at a pivotal juncture for the body’s efforts to advance their goal of a sustained and balanced global recovery. The meeting will be dominated by pressure to avert a so-called currency war, as China and other countries in Asia boost their export through various moves to limit their currencies’ appreciation, measures which the United States and other advanced economies say puts their manufacturing sectors at a disadvantage.

``Heightened tensions in currency markets and related risks associated with global imbalances could result in a more protracted and difficult global recovery,’’ Mr. Carney said.

In addition, the U.S. Federal Reserve is widely believed to be on the verge of taking fresh action to solidify the flagging U.S. economy, steps that would keep the American dollar down and send investors who want higher yields to currencies like the loonie.

Overseas investors are attracted to the loonie in part because Canadian rates are higher than in the U.S., where the Fed's main rate is still close to zero. Raising rates while the Fed and other key policy makers like the European Central Bank are still on hold could cause a rapid spike in the loonie, which would make Canadian products more expensive to foreign customers.

The loonie was down by as much as 2 cents (U.S.) in the hours after Mr. Carney’s decision.

Noting that while Canada’s recovery will be more dependent on investment by the private sector and exports as the impact of government stimulus fades and Canadians spend less, Mr. Carney warned that the strength of the country’s exports will be a function of several factors including currency movements and ``prospects for external demand.’’

The central bank will release a full analysis of its economic outlook on Wednesday.

Aside from Mr. Carney’s suggestion that he will be on alert for any worrisome movement by the Canadian dollar, Tuesday’s statement included a couple more hints that he could stay on the sidelines through his next decision on Dec. 7, or even longer.

The bank revised its projection for when inflation will return to Mr. Carney’s 2-per-cent target, as well as its forecast for when the excess slack in the economy will have been chewed up. Both are now projected to happen at the end of 2012, instead of the beginning of that year.

However, Mr. Carney also pointed out that his decision to pause leaves ``considerable monetary stimulus’’ in place -- with the benchmark at a still-very low 1 per cent -- in keeping with his sharper warnings in recent weeks about the dangers of taking on debt that won’t be affordable when borrowing costs return to more normal levels.

 

"A sluggish recovery south of the border and softer-than-expected Canadian growth in the second half of 2010 have pulled the Bank of Canada back onto the sidelines, though the (now less urgent) tightening bias remains in place,’’ said Robert Kavcic, an economist with BMO Nesbitt Burns, said in a note to clients. ``We judge they will remain on hold until May, 2011.’’

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