Bank of Canada keeps interest rate anchored at 1 per cent

OTTAWA – The Bank of Canada is keeping its trendsetting interest rate anchored at one per cent for the remainder of the year and sending a message that it still believes the cost of borrowing will go up at some point in the future.

The decision by the central bank’s policy setting panel was in line with the expectations of markets and economists, who had given only low odds to governor Mark Carney removing a mild bias towards raising rates sometime.

The dollar gained strength after the announcement. It was up 0.19 of a cent to 100.7 cents U.S. — slightly higher than just prior to the central bank’s announcement.

The bank’s statement Tuesday acknowledged the economy is weaker than it expected, but suggested it is mostly looking through the soft patch as a temporary aberration.

Last week, Statistics Canada reported the country’s gross domestic product output had slowed to 0.6 per cent — about half what the bank had predicted in October, and the weakest result in more than a year.

“Although underlying momentum appears slightly softer than previously anticipated, the pace of economic growth is expected to pick up through 2013,” the bank stated.

Tying improved conditions to 2013 suggests Carney, who has announced his intention to step down in June to take charge of the Bank of England, now realizes the economy is unlikely to live up to his 2.5 per cent hopes in the fourth quarter as well.

Bank of Montreal deputy chief economist Doug Porter added Carney has no choice but to await the outcome of ongoing “fiscal cliff” negotiations in Washington designed to head off automatic tax increases and spending cuts in January. Policy-makers have calculated the shock could be enough to send both the U.S. and Canada back into recession.

“I think the bank is hedging their bets on the expected upturn of the Canadian economy,” Porter explained.

“We could have the Republicans and Democrats holding hands and singing Kumbaya and the markets would have a tremendous rally and the economy could come flying out of the gate in 2013. The opposite is that we get a bit of a train wreck.”

As it is, Carney said the uncertainty over whether Washington will be able to avoid figuratively going over the cliff is already impacting the economy, another reason for looking through the current weakness.

Retaining the bias for higher rates — even as the economy softens — serves Carney’s purpose of reminding consumers not to count on super-low rates indefinitely.

In a bit of a surprise, he said he is not as yet convinced the recent cooling in housing activity in Canada, and slowdown in credit accumulation, represents a fundamental shift, indicating he remains concerned about the downside risk of keeping rates low for a very long time.

On Monday, Finance Minister Jim Flaherty said he was pleased housing was moderating and that Canadians were starting to pay off debt, a shift in the credit and mortgage market he attributed in part to his decision to tighten borrowing rules in July.

Carney said, however: “It is too early … to determine whether the moderation in housing activity and credit will be sustained.”

While the central bank appears to be waiting for the trend to take hold, Scotiabank economist Derek Holt expects Carney will have all the evidence he needs by spring or summer, when the housing correction “starts as a steep plunge in new condo sales.”

“As housing leads the downsides, I think the consumer picture may not lead growth as much as the BoC seems to be hoping,” he said.

Otherwise, not much has changed in the past month or so, the bank says. Europe is still in recession, the U.S. is recovering but at a gradual pace and Chinese growth appears to be stabilizing. If there is good news for Canada in all this, it’s that commodity prices have remained elevated, which helps the country’s terms of trade.

The decision Tuesday was the 18th consecutive time Carney has kept the policy rate at one per cent, comprising over two years, the longest stretch of stability since the 1950s.

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