The Bank of Canada left interest rates unchanged on Wednesday, saying the economy remained roughly on track despite slower growth and the increased risk posed by a downturn in the US housing market.
The central bank left its key overnight rate at 4.25 percent for the second straight time after raising rates seven times between September 2005 and May of this year. Markets had widely expected the bank to hold rates steady.
In its statement accompanying the rate decision, the bank was not as dovish as had been expected, leaving analysts less sure about its next moves.
Markets had begun to factor in a rate cut by early 2007 amid signs that Canadian exports were staggering under the impact of a stronger currency and dropping US demand. But the bank repeated its July assessment that the downside and upside risks to the economy are "roughly balanced."
"I think they wanted to tweak expectations a little bit, perhaps the market had got a little ahead of itself in thinking rate cuts were coming," said Ted Carmichael, head of research at J.P. Morgan Canada. Carmichael is one of a minority of analysts calling for a rate increase either by year-end or early next year.
The Canadian dollar rose after the rate announcement. At 10:15 am (1415 GMT), the currency was at C$1.1061 to the US dollar, or 90.41 US cents, up from C$1.1117, or 89.95 US cents, before the bank's statement. Bond prices extended their earlier losses.
Weaker exports dragged down Canadian economic growth in the second quarter to a disappointing 2.0 percent, versus the bank's outlook for 3.2 percent, and well down from the first quarter's roaring 3.8 percent. Both core inflation and overall inflation in July came in higher than the bank had expected due to higher prices for housing and services.
"Looking forward, the bank continues to expect the Canadian economy to operate at about its production potential, with total CPI (consumer price index) inflation returning to the 2 percent inflation target in the second half of 2007," the Bank of Canada said in a statement. "In line with this 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," it stated.
In its July rate announcement, the bank said the economy was running at "just above" capacity and would return to capacity by the end of 2008.
Andrew Pyle, senior economist at Scotia Capital, said the changed language on production potential signals the bank is "gingerly shifting its stance" toward the possibility of easing rates in early 2007 "pending observation of how US housing conditions pan out and whether there is any revival in Canadian domestic demand".
Primary securities dealers polled by Reuters had unanimously forecast no rate move by the bank on Wednesday. Eleven of the 13 survey participants expect no rate changes by the end of this year, while two forecast an increase to 4.50 percent, either in October or December.
The bank flagged slowing US household demand as a key downside risk to the Canadian economy, which would further dampen already hurting exports. Strong Canadian demand and housing prices pose the main upside risks, it said. It said both risks were slightly greater than in July.
"While acknowledging the potential for slightly greater event risk to the forecasts, the overall view continues to support the view that the Bank of Canada remains sidelined (on rates) for the rest of 2006," said Stewart Hall, market strategist at HSBC Securities.
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