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

By: Maria Babbage, The Canadian Press

Posted: 3:02 AM | Last Modified: 11:13 AM

Bank of Canada Governor Stephen Poloz gestures during a news conference in Ottawa, Wednesday, Jan.22, 2014. THE CANADIAN PRESS/Adrian Wyld

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Bank of Canada Governor Stephen Poloz gestures during a news conference in Ottawa, Wednesday, Jan.22, 2014. THE CANADIAN PRESS/Adrian Wyld

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 its 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.

It expects the total inflation rate to remain at 0.9 per cent in the first half of 2014, down from its previous forecast of 1.2 per cent, but should “increase very gradually” and reach the bank’s ideal target of 2.0 per cent in last quarter of 2015.

Canada’s economic growth in the second half of 2013 was better than expected and should pick up from an estimated 1.8 per cent last year 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 Canadian dollar pulled back more than half a cent following the bank’s report, dropping 0.58 of a cent to 90.56 cents U.S, closer to lows set in early September 2009.

The currency has lost nearly four cents since Dec. 31, when it closed at 94.02 cents US, due to a combination of factors including a strengthening U.S. dollar, weak prices for commodities and Canada’s low-interest, low-inflation environment.

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

That was the key phrase, said BMO chief economist Doug Porter.

“This is a strong statement for the Bank, and as close as they will come to saying the currency is still overvalued and, thus, further depreciation is welcome,” he wrote in a note.

Porter also noted that the emphasis the potential for inflation to be too low was “ramped up at notch” in the bank’s latest statement.

CIBC’s Peter Buchanan said the statement “retains a broadly dovish flavour, although the bias as before remains broadly balanced between a possible rate reduction and potential increase.”

The bank expects global growth — led by stronger momentum in the U.S. — 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 total inflation rate was 0.9 per cent in November, 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.

Statistics Canada will release its December inflation figures on Friday.

“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.

As expected, the statement retains a broadly dovish flavour, although the bias as before remains broadly balanced between a possible rate reduction and potential increase.

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.

Source: Winnipeg Free Press