Bank of Canada keeps interest rate at 1 per cent, but keeping eye on inflation

OTTAWA – The Bank of Canada is lowering its forecast for inflation, which has been persistently below the desired target, but keeping its key interest rate unchanged at 1.0 per cent.

The central bank is maintaining neutral stance on whether it’s next move will be to raise or lower the rate from where it has been for more than three years, amid a weak economy and low inflation.

While it sees improvements in the Canadian economy, the Bank of Canada said inflation is now expected to be lower than previously projected — in part because of price competition among retailers.

The bank said it expects Canadian inflation will “increase very gradually” to the ideal target of 2.0 per cent in about two years.

Canada’s economic growth in the second half of 2013 was better than expected and should pick up from 1.8 per cent in 2013 to 2.5 per cent in both 2014 and 2015, it said. Stronger demand in the United States as well as the lower loonie should help boost exports, which will also improve business confidence and investment.

The dollar was trading below 91 cents US on Wednesday morning.

“Despite depreciating in recent months, the Canadian dollar remains strong and will continue to pose competitiveness challenges for Canada’s non-commodity exports,” the report said.

Global growth — led by stronger momentum in the U.S. — is expected to rise from 2.9 per cent in 2013 to 3.4 per cent in 2014 and 3.7 per cent in 2015.

But the bank noted that inflation in Canada is expected to “remain well below target for some time,” in part due to increased competition in the retail sector — which keeps the price of goods and services low — and excess capacity.

So the downside risks have grown in importance, it said.

“The most important risks are stronger U.S. investment, underperformance in Canadian exports, and imbalances in the household sector,” it said.

Canada’s inflation rate rose in November to 0.9 per cent, but it was the seventh month in the past 13 months where the official headline inflation reading came in below the bank’s desired broad range of between one and three per cent.

And it’s been consistently below the ideal target of two per cent, adding further justification to the Bank of Canada’s reluctance to raise interest rates.

“The significant and persistent slack in the Canadian economy has contributed to a marked increase since mid-2012 in the proportion of core consumer goods and services for which prices are increasing by less than two per cent,” it said.

“Heightened competition in the retail sector is also contributing to the weakness in inflation.”

But the bank said the balance of risks remains within the same zone as its last report in October, so it’s decided to maintain its key interest rate target.

Central banks are usually more preoccupied with high inflation, but low inflation is equally concerning because it’s evidence of weakness in real economic activity and could lead to deflation, where prices actually decline absolutely.

The bank says it will make its next interest rate announcement on March 5 and release its updated outlook for the economy and inflation — including risks to the projection — on April 16.