Bank of Canada maintains key rate at 1% Boosts outlook for Canadian economic growth

The Bank of Canada kept its target for the overnight rate at one per cent for the third consecutive meeting on January 18th, 2011. Correspondingly, the Bank rate remained at 1.25 per cent and the deposit rate remains at 0.75 per cent.

The Bank said that the global economic recovery was proceeding at a somewhat faster than expected pace, but noted that risks remain elevated. The main source of uncertainty to the global outlook remains sovereign debt concerns in several European countries.

The driver of the improvement in the global outlook was the pick-up in private domestic demand in the United States, which the Bank said would be further supported by recently announced monetary and fiscal stimulus, specifically, the Federal Reserve’s $600-billion asset-purchase plan and the extension of the Bush-era tax cuts.

The Bank noted that stronger global growth had contributed to a significant increase in commodity prices since the October Monetary Policy Report (MPR), but pointed to headwinds going forward, as emerging markets like China have already begun to take steps to keep their economies from overheating. More restrictive policy measures in emerging markets could cool demand for commodities, and put downward pressure on prices.

In Canada, the Bank said the recovery was proceeding broadly as anticipated. The Bank gave a small boost to the outlook for the Canadian economy, projecting growth of 2.4 per cent this year and 2.8 per cent in 2012. This is up from the forecast in the October MPR of 2.3 per cent this year and 2.6 per cent next year.

Despite the marginal increase in the outlook, it will nevertheless be a period of more modest growth, characterized by a rebalancing of demand away from government, consistent with announced fiscal plans, and households, whose balance sheets are increasingly stretched.

Picking up the slack will be continued strong growth in business investment and stronger net exports. While net exports are expected to improve with the uptick in U.S. activity and global demand for commodities, the Bank repeated its belief that headwinds would continue in the form of Canada’s poor relative productivity performance, and the persistent strength in the Canadian dollar.

The Bank did not alter its view that inflation would return to its 2 per cent target by the end of 2012, as the slight improvement in the outlook for growth was offset by soft growth in the second half of 2010.

Financial markets have been pricing in the next rate hike in March, but this is increasingly unlikely given the absence of any sort of hawkish tone in today’s announcement. Economic analysts remain largely of the view that the Bank will stand pat until July.

While the overnight rate remains very accommodative, the Bank nevertheless reiterated its statement that “any further reduction in monetary policy stimulus would need to be carefully considered.” While no mention was made of the recently announced changes to mortgage rules, these are generally viewed as giving the Bank some breathing room in the near-term. The strong Canadian dollar continues to be cited as a main risk to the expected improvement in the export sector. As such, the Bank does not want to get too far out in front of the U.S. Fed.

Mortgage lenders have also kept their rates on hold. As of January 18th, 2011, the advertised five year lending rate stood at 5.19 per cent. This is unchanged from December 7th, 2010, when the Bank made its previous policy interest rate announcement.

The Bank’s next Monetary Policy Report will be published on January 19th, 2011. The Bank will make its next scheduled rate announcement on March 1st, 2011.

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