Canada Raises Key Interest Rate, Warns About Recovery

Wednesday, 08 Sep 2010 10:43 AM

 

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The Bank of Canada raised its benchmark interest rate and said the country’s recovery will be slower than it had projected because of a weaker outlook for the U.S. economy.

The bank raised its target rate for overnight loans between commercial banks to 1 percent from 0.75 percent, matching estimates from 14 of 20 economists surveyed by Bloomberg. Further increases would need to be “carefully considered” given uncertainty around the outlook, it said.

“The bank now expects the economic recovery in Canada to be slightly more gradual than it had projected” in July, policy makers said in a statement. “Any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook.”

Policy makers, who next meet Oct. 19, may be unwilling to tighten policy further in coming months as Canada’s economy expanded more slowly than anticipated in the second quarter, and as the U.S. proposes additional stimulus amid signs of renewed weakness. Last month, diminishing prospects for U.S. growth sent global stocks tumbling and prompted the Federal Reserve to signal the possibility of further monetary measures.

“Because of the recent economic data in the U.S. and Canada, the bank will significantly revise its outlook downward in October, and that will open the door for a pause,” said Benoit Durocher, an economist with Mouvement Desjardins, Quebec’s largest credit union, in Montreal.

The U.S. rebound is being restrained by high joblessness, the bank said, adding “recent indicators suggest a more muted recovery in the near term” for the world’s largest economy.

The statement dropped a reference from the previous announcement in July that future tightening would need to be “weighed carefully against domestic and global economic developments.”

The Canadian dollar rose after the increase, gaining 0.7 percent to C$1.0407 per U.S. dollar at 9:33 a.m. in Toronto, from 1.0480 late Tuesday.

The increase was the bank’s third since June, and most economists, including Durocher, now forecast Governor Mark Carney will keep the rate at 1 percent until April.

Canada “remains on sounder footing than the U.S., but all eyes are focused on U.S.,” said Anil Tahiliani, a fund manager at McLean & Partners Wealth Management in Calgary, Alberta, in an e-mail before the announcement. “After this small increase of 0.25 percent, the BOC will go on hold since the economy is starting to slow and global economic concerns take front stage.”

Canada’s increases are the first among Group of Seven countries after last year’s global recession. The country has recovered from the slump faster than the U.S., having already returned to pre-recession levels of employment. Consumption and investment have “evolved” as anticipated and are expected to remain buoyant, the bank said.

“Consumption growth is expected to remain solid and business investment to rise strongly,” the bank said. “Both are being supported by accommodative credit conditions, which have eased in recent weeks mainly owing to sharp declines in global bond yields.”

The bank said that while financial conditions in Canada have “tightened modestly” because of the increases in interest rates, monetary policy remains “exceptionally stimulative.”

“This is consistent with achieving the 2 percent inflation target in an environment of significant excess supply in Canada,” the Bank of Canada said. Inflation in Canada has been broadly in line with expectations, it said.

The Canadian economy, after growing at an annualized 5.8 percent pace in the first quarter, slowed in the April-June period to a 2 percent rate — a full percentage point below the central bank’s July prediction. As well, employers cut workers in July for the first time this year and the core rate of inflation, which is closely watched by the bank, unexpectedly slowed to 1.6 percent that month.

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